A common fear of small business owners is becoming insolvent and going bankrupt. Starting a new business can be challenging, particularly during uncertain economic conditions.
According to ASIC, the number of companies appointing external administrators in fiscal 2012 was at its highest level since the global financial crisis, while company collapses for the first seven months of fiscal 2013 were the second-highest on record. “We predict 2013 will continue to see high levels of insolvencies due to continued volatility in a number of sectors, the high Australian dollar and tight debt and equity markets,” accountancy Taylor Woodings told AAP. Given the tough business environment, how can owners reduce the risk of insolvency?
Get a plan
Insolvency is defined* as being unable to pay a company’s debts when they fall due. Penalties for insolvent trading include civil penalties against directors of up to $200,000, along with potentially unlimited compensation payments and even criminal charges. As a result, proper cash flow planning is vital, according to Michael Cameron, director at accountancy and business advisory firm Williams Hall Chadwick.
“The key for new businesses is working through a budget so you know what your working capital requirements are in the worst-case scenario,” says Cameron. “You need to ensure you have funding available to get through those initial periods when income can be lumpy or poor, until the business starts to gain traction.”
Cameron suggested developing a three-way forecast, which comprises an analysis of cash flow, profit and loss, and the balance sheet. “Three-way forecasts are useful tools for all businesses. Banks are also regularly looking for these when assessing loans to clients, as they allow for an assessment of stock movement, non-cash items, debtors and creditors.”
Take action early
Early action is essential to avoiding business failure and can even help set the stage for future growth. Danger signs can include the loss of a major customer, suppliers placing your business on cash-on-delivery terms, problems selling stock, loan defaults and being chased by the tax office for late payments. The first action should be consulting your accountant or business advisor, as well as approaching your lender about obtaining an overdraft extension or other support.
Turnaround advisers can also assist, although beware loan sharks seeking excessive interest rates. A common approach is chasing invoices faster to get debtors paying more quickly, while negotiating extended payment terms with creditors. Consider offering discounts to customers who pay early, as well as engaging a debt collector if bills extend beyond 60 days outstanding.
If the situation is untenable, one option is entering into voluntary administration, a relatively simple process that can give some breathing space. Retailer Damien Scarf and Tasmanian salmon producer Tassal are two examples of businesses that have successfully rebounded after entering into administration, which is far preferable to the alternatives of liquidation or receivership. Surviving in tough times can be difficult, but by doing the right planning, seeking advice and acting early it can be possible to avoid the threat of insolvency.
* This is the definition as per the statute, not as defined by ASIC.[Sources]