A case identified the 14 indicators of insolvency. To run a business, you must contend with a lot of factors, some of which may be beyond your control (e.g. economic crisis). Success also does not come easy as it takes long hours of hard work to get even just one customer through your door. It is a shame then to realise somewhere along the way that you lost your business without even knowing what went wrong.
In this article, we take you through a comprehensive list of 14 indicators of insolvency. This list is in addition to the warning signs we wrote in an earlier post. Insolvency is being unable to pay debts in full as they become due. While insolvency is not the sole reason why a business crumbles, insolvency, when not managed well, can lead to collapse. Moreover, being unaware of insolvency and, consequently, continuing to trade while insolvent, has severe repercussions to the business and the director who has a statutory duty to prevent an insolvent company from trading.
This list of 14 indicators of insolvency was taken from the case ASIC vs Plymin (2003). In that case, the Supreme Court of Victoria ultimately held two directors liable for not preventing two companies from trading while insolvent. The Victoria court noted that insolvency is a typical occurrence during the life of a business. However, the directors should have done something so that the companies were stopped from incurring more liabilities, the court held.
14 Indicators of Insolvency
- Continuing losses.
- Liquidity ratios below 1.
- Overdue taxes.
- Poor relationship with Bank.
- No access to alternative finance.
- Inability to raise further equity capital.
- Suppliers placing the company on COD.
- Creditors being unpaid outside trading terms.
- Issuing of post-dated cheques.
- Dishonoured cheques.
- Special arrangements with selected creditors.
- Solicitors’ letters, summons, judgments or warrants issued against the company.
- Payments to creditors of rounded sums.
- Inability to produce timely and accurate financial information.
Any of the 14 indicators of insolvency, when taken alone, does not signify insolvency. Losses, for example, should be continuing for successive periods because losses are also common in business. Likewise, dishonoured cheques also happen all the time indicating a shortage of short-term cash flow but not indicating insolvency. The company’s financial status should be tested against two or more indicators to suspect insolvency.
In the Plymin case, one of the accountants who served as witness pointed out that the company incurred a loss of $879,000 for the year ended December 1998, with the loss substantially increasing to $6.165M for the year ended December 1999. That accountant placed emphasis on the company’s working capital ratio, which was 0.77 in September 1999 and 0.59 in October 1999, if the company’s debt with ANZ Bank is treated as a current liability.
Aside from these indicators, we have also written about how industry competitiveness, efficiency, and customer base indicate that your business may be in a need for restructuring.
Time wasted is money wasted. The time the director acts upon the insolvency of the company matters in the imposition of liabilities. Act too late and there will be dire consequences — the company can be placed in liquidation, away from your control, and the director will face personal liabilities. Also, the collapse of a company has a domino effect on your employees, your lenders, your customers, and your suppliers. Your business may just be one in a million other companies, but it is also part of a bigger economy, and one downfall could affect a hundred others. Don’t put off until tomorrow what can be done today, because one day may mean a difference, especially when it comes to regulatory compliance.
Many business owners are wary of seeking outside help when they experience any one of the 14 indicators of insolvency for many reasons. One of these is a lack of understanding of what is going on and what is going to happen. Many business owners let go of years of hard work because they are not aware that they still have options to save their business. There are professionals whose expertise is to help businesses get back on track. To cite an example, if you have continuing losses because your suppliers have been paying beyond 30 days, consider hiring a debt collection agency who can give a little push to make suppliers pay. If you are short of cash and need more funds, consider going to financiers for alternative financings, like invoice finance or angel investing.
Be open to changes.
Most of all, be ready to changes. When you seek the help of professionals for your business, there will be countless options for you to take — or none, depending on how early you acted upon your financial problems. Depending on the situation of your business based on the 14 indicators of insolvency, your options may include complete liquidation, new financing, renegotiation of some contracts, or voluntary administration. Whatever changes you have to make, if you act early and you seek help from experts, you will be making informed decisions to will not be the best option for your company but also for you as a business owner or director.
Here at Infinity Factors, your business cash flow specialist, you help you extend your financial lifeline through invoice or debtor finance, to, hopefully, avert a financial collapse.