The Critical Importance of Early Action
We have seen many instances where directors have waited too long before taking decisive action to deal with their company’s financial difficulties. In some cases, the outcomes which may have been achievable from an early voluntary administration are diminished or lost completely, due to the build-up of trading losses and other damage, including the crystallisation of directors’ guarantees on leases and equipment finance contracts which are in default.
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It is vitally important to act early, before the asset pool is depleted from trading losses, and before enforcement action by unsecured creditors leads to a DOCA becoming increasingly difficult and expensive to implement.
It is possible to appoint a voluntary administrator to a company facing a winding up application in the courts, and improved outcomes are possible—but the process becomes increasingly expensive, with the need to engage lawyers and perform additional work that may not have been necessary if the process had commenced earlier.
Courts are often critical of company directors appointing an administrator just before the hearing of a winding up application. You may find that the Court orders the termination of the voluntary administration and the appointment of a liquidator—in particular where there is no clear evidence of any benefit to the company’s creditors of the voluntary administration remaining on foot.
Director Penalty Notice! What are they, and what are the consequences?
The Australian Tax Office may issue a DPN against you if your company does not pay PAYG (pay-as-you-go) tax deducted from employee wages, GST and superannuation guarantee amounts on time. If you receive a DPN, you must act immediately.
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The director penalty notice (DPN) regime is set out in subdivision 269-B of Schedule 1 of the Taxation Administration Act, 1953.
Directors have a continuous personal liability to pay PAYG deductions, SGC and GST to the Australian Taxation Office. But the ATO can only enforce that liability if it first issues a DPN, and the DPN is not complied with.
Are your BAS returns (and if applicable, SGC statements) up to date?
Where unpaid taxes are reported within three months of the due date for lodgement (or by the due date, for SGC), directors have 21 days from the date of issue of the notice to act.
To avoid personal liability, directors must do one of the following within 21 days of the DPN:
- Pay the tax;
- Appoint an Administrator;
- Appoint a Small Business Restructuring Practitioner; or
- Appoint a Liquidator.
Failure to do one of the above will result in an enforceable personal liability attaching to the director. The ATO is then able to sue the director personally for recovery of the outstanding amount. This will usually mean that if the company cannot pay, the director must pay the debt from their personal funds, or face bankruptcy.
Lockdown DPN
If your BAS returns are more than three months overdue for lodgement or you have unpaid SGC that was not reported by the due date, and you receive a DPN covering the unreported debt, personal liability can only be avoided by your company paying the debt.
It is essential that a DPN is not ignored, but is acted upon, without delay.
New Director?
If you’re contemplating becoming a director of a company that has unpaid PAYG, GST and/or SGC liabilities, be aware that you will become personally liable for that debt 30 days after your appointment. If the company subsequently cannot pay the debt, you could become liable to pay the company’s unpaid debt – incurred when you were not a director!
What is a Statutory Demand? What impact does it have?
A statutory demand is a notice to a debtor company (issued under section 459E of the Corporations Act) requiring payment of a debt due (or to secure the debt or enter into an agreed payment arrangement) within 21 days. The debt must be $4,000 or greater.
Non-compliance with a statutory demand is the most common basis for a creditor to file an application for a winding up of a debtor company.
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A prudent creditor will have first obtained judgment against the debtor company before issuing the demand, to minimise the chance of the debtor seeking to have the demand set aside by raising a defence or counterclaim (a defence or counterclaim should be raised within the time specified on the originating motion or complaint – before the court makes a judgment).
A statutory demand must not be ignored. To do so will likely result in a winding up application being filed against your company.
If the debt is disputed but no appearance or defence was made at the hearing prior to issue of judgment, the court will not look favourably at an application to have a later statutory demand set aside.
An application may be made to have a statutory demand set aside on the grounds that it is defective.
If a creditor has served a statutory demand on your company and the debt is not disputed, but you do not have the money to pay, contact us for a free, no obligation discussion of your options.
What is Insolvent Trading?
Company directors have a statutory duty to ensure their company remains solvent – that is, able to pay its debts as and when they fall due.
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If a director allows the company to incur a new debt when there are no reasonable grounds to believe that debt and/or the company’s existing debts can be paid when they fall due, the director may have contravened the Corporations Act (section 588G) by trading while insolvent.
Indicators that your company may be trading while insolvent can be found here.
The Corporations Act empowers a liquidator – or in certain cases, individual creditors – to sue a director for compensation for the loss sustained by reason of the director’s breach of the insolvent trading laws.
Regardless of who sues, the insolvent company must first be in liquidation before any action is possible.
The amount of compensation that can be pursued is equal to the value of the new debts that were incurred by the company at a time when it was insolvent. Or in the case of an individual creditor, only the debts to that creditor are counted.
Determining when a company becomes insolvent is not an exact science. It involves an assessment of the weight of evidence of insolvency indicators.
Though the definition of solvency in section 95A – ability to pay one’s debts as and when the fall due – seems straightforward at first glance, in practice the courts do not interpret the Corporations Act that literally.
A distinction is made between temporary illiquidity and hard-core insolvency. The first is a condition from which it may be reasonable to expect that, with sound management and a bit of good luck, the debtor company can recover, by trading out of difficulty, restructuring debts or selling assets. The second is a terminal condition from which it is reasonable to believe that the company almost certainly cannot recover.
The point at which recovery is no longer possible can be difficult to identify precisely. There are many factors that must be considered when assessing whether a company is presently solvent, or was solvent at a particular point in time. This is a complex area of the law. Company directors who believe their company may be insolvent are obliged to seek urgent professional advice and to act appropriately according to the circumstances.
How business failure destroys value in company & personal assets
When a business gets into financial difficulty, invariably there is loss of value in the company’s assets. Loss of value in personal assets often follows. Loss can occur in many ways, and affect all types of assets.
Read more to see examples of value destruction.
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Purchased goodwill
A profitable business purchased as a going concern will likely include goodwill in the purchase price. This is the difference between the purchase price and the fair market value of the fixed and circulating assets acquired. The value of purchased goodwill is directly related to the profitability and growth prospects of the business, and often represents a large part of the price of a business bought as a going concern. If a once-profitable business starts to incur trading losses, the value of purchased goodwill can evaporate overnight. Goodwill is a function of profitability. In SME businesses, no profitability usually means no value in goodwill.
Fixed assets
Fixed assets such as vehicles, specialised plant and machinery, computers, office furniture and fittings, and leasehold improvements are typically bought for ‘fair market value’ when a business is acquired as a profitable going concern. But these assets can fall in value dramatically when business failure occurs.
When estimating the value of fixed assets, valuers and auctioneers speak of differing valuation bases, typically ‘fair market value for existing use’ and ‘auction realisation value’. The former assumes use of the assets can be optimised in a profitable business – that the assets are being put to their highest and best use, for the purpose they were built. But where the business is unprofitable and cannot be resurrected, the assets may need to be sold at ‘auction realisation value’ – perhaps only a fraction of the market value for existing use.
Not only is it likely the assets will be sold in distressed circumstances to bargain hunters, if relocation to auction rooms is required, costs will be incurred in decommissioning and uplifting plant, transport, storage, advertising and sales commission. These costs, deductible from an already heavily depreciated value due to the business failure, may result in a catastrophically small recovery from realisation of fixed assets.
Book debts
When a business is known to be in financial difficulty, its debtors may find reasons to slow down or cease payment of money owed, a situation less likely to occur in normal circumstances. The action could be motivated by:
- a fear that warranty claims will not be honoured;
- a concern that ongoing supply may no longer be available, thus imposing costs of sourcing alternative supply;
- possible re-tooling costs associated with a change of supplier;
- in the case of contract progress payments:
- a concern that the supplier will be unable to complete a project, and the costs of sourcing an alternative contractor will exceed the amount remaining to be paid under the contract;
- the costs of delays associated with sourcing alternative supply (particularly relevant on large development contracts involving a chain of contractors and subcontractors);
- a perception that the business is ineffective at pursuing payment of monies due (why pay when you’re not being chased?);
- inequality of bargaining power, where the debtor perceives an ability to change payment terms at will and the supplier is relatively powerless to challenge this action.
A business in difficulty can thus find the recoverable value of its book debts falling away due to counterclaims and the costs of litigation to recover debts due.
Value erosion in the owner’s personal assets
Loss of business value can quickly begin to impact on the owner’s personal assets. This can occur as a result of:
- personal guarantees to trade suppliers, financiers and/or landlords being called up due to arrears of payments due;
- where company directors have signed pledges over personal assets to support personal guarantees (increasingly common), the creditor may have rights to lodge a caveat over the director’s home or other real property;
- the issue of a Director Penalty Notice by the Australian Taxation Office may give rise to personal liability for arrears of PAYG tax deducted from employee wages, GST and unpaid superannuation guarantee amounts; and
- trading while insolvent.
The full extent of the damage arising through incurrence of these liabilities is often only visible after the event, when it may be too late to mitigate or avoid the loss.
Act quickly to prevent asset value erosion
Proactive communication with creditors is critically important
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If your business is in difficulty, one of the worst mistakes you can make is to ‘go to ground’ and refuse to communicate with your creditors. Not only will your relationship with the supplier quickly sour, there may be swift and harsh recovery action against your company.
On the other hand, frank and honest communication with your creditors, such that they understand the difficulties being faced by your company, is likely to be met, at least initially, with a preparedness to tolerate late payment without taking early legal proceedings.
However, do not mislead a creditor about your company’s ability to pay its debt. A common and critical error made by directors is to promise payment of the debt by a certain date when the director has no reasonable basis for believing the debt can be paid by that date. Usually this is done to get the creditor ‘off your back’ and buy some short-term breathing space. But the creditor’s anger is significantly magnified when the debt is not paid as promised. And your credibility with the supplier is destroyed.
Of course, no creditor will wait indefinitely for payment. But no matter how bad your situation becomes, you will almost always receive better treatment from creditors if you’re honest and up front with them, and you engage with them about your situation.
During any negotiated period of creditor indulgence, you should seek professional advice concerning the financial circumstances of your company. If it appears that your company may be heading toward insolvency, urgent action is required to mitigate ongoing loss and damage.
A common mistake by business owners in difficulty is to do nothing during the period of indulgence agreed to by the supplier, in the hope a solution will fall out of the sky. Then when the extended date for payment falls due and payment cannot be made due to lack of funds, not only have you wasted a window of opportunity to seek professional advice, there has been a further accrual of loss and damage to your company.
Contact us as soon as possible for confidential advice.
Why your business may be running out of cash
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Some of the more common causes of business cash flow problems are:
- slow paying debtors;
- excessive stock holdings;
- slow moving or obsolete stock;
- pressure on margins from excessive competition in the market;
- loss of a major contract;
- staffing inefficiencies – wage costs are excessive for the business;
- high capital repayments on bank loan facilities;
- excessive premises rent, not commensurate with market realities;
- employee retrenchment costs;
- excessive owner/director drawings; and
- drawing funds from the business to prop up a struggling related business
Cash flow is the life blood of all businesses. Every business with inadequate cash flow will fail, sooner or later, if problems are not addressed.
Inadequate cash flow is a serious problem that must be tacked as soon as possible, before the issue becomes too serious to resolve and leads to business failure.
We can assist you to identify the problems and implement corrective action before it’s too late.
Slow paying debtors or bad debts are starving your business of cash flow
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Often the debtor is genuine and doing all they can to pay you as quickly as possible. In other cases they may be paying other creditors and deferring payment to you, or making promises to pay which are not kept. Perhaps they have stopped communicating with you altogether.
We have had many years’ experience dealing with debtors and creditors on ‘both sides of the fence’. As consultants, we can assist with negotiations with your debtor, to obtain a realistic payment proposal supported by cash flow forecasts, help preserve your relationship with the debtor and maximise the chances of being paid and of maintaining an ongoing business relationship.
If a large debt proves uncollectible, we can assist you to develop and implement a strategy to deal with the cash flow impact of the bad debt.
In the worst case, if a bad debt renders your own business insolvent, we can help with a turnaround or exit strategy. If you act early there may be cheaper and more effective alternatives to the appointment of an external administrator.
We can assist you to effectively manage difficult debtors before it’s too late.
A major contract has become unprofitable
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In some industries, unscrupulous operators may try to coerce suppliers with limited bargaining power into accepting discounts on debts due, on the promise of the next contract being profitable. Such operators can be ruthless in their conduct, with no care for the supplier’s business. Often they’re facing cost pressures of their own, and have no qualms about sending a small, low value supplier to the wall in order to keep their own costs down.
If you are that supplier, these types of arrangements can have a disastrous impact on your business. Usually, the superior bargaining power of your client or head contractor means there may be little in the way of viable options available.
If you believe your company may be currently servicing an unprofitable contract, contact us now to discuss your options.
We can assist you to work through options to deal with a loss making contract before it’s too late.
Your bank has refused to extend the overdraft or another lender has refused finance
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When you ask for more credit the bank will want to review your financial accounts and ask what the funds are to be used for. Unfortunately, if the funds are needed to pay tax arrears, you’re likely to have difficulty persuading the bank to lend.
If your financial accounts disclose a loss, or there is some other issue of concern, the bank is likely to decline your request, even where adequate security is available. Your own bank may even ask you to take your business elsewhere.
The bank will not want to advance your company further funds unless they’re satisfied it can be paid back. That’s hard to do if your business is unprofitable or in a weak financial position.
If you’re knocked back for funding, we can help by reviewing your company’s overall situation and giving you our honest opinion as to whether we think you can trade out of difficulty if the additional working capital becomes available. We won’t recommend you borrow more money if it will only be used to fund future trading losses – unless this is part of a clearly defined turnaround or exit strategy.
If we think your business would benefit from additional funding, or a rearrangement of your business funding structure, we can assist you with the preparation of loan submissions to financiers, and with negotiations to secure the required funds.
Alternatively, a business restructure may be the better option.
We can review your company’s funding facilities and work out the best option to take.
Importance of good record-keeping
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Legal obligation
The legal obligation to keep proper records is found in section 286 of the Corporations Act, which requires every company to keep written records that correctly record and explain its transactions, and would enable true and fair financial statements to be prepared and audited. The records must be retained for 7 years.
The courts have held that it is not sufficient to keep a shoe box full of tax invoices, receipts and bank statements. Source documents must be kept of course, but it is also necessary to maintain, as a minimum, a general ledger, cash book and debtor and creditor ledgers where the transactions are recorded, totalled and reconciled.
Inadequate records? Presumed insolvency!
Except for minor or technical breaches, the Corporations Act provides that where a company has failed to keep and retain records as required by section 286, the company is presumed to have been insolvent throughout the whole of the period for which records have not been kept. This can have major implications for the directors, where a company is later placed into external administration. For example, directors can be held to have traded whilst insolvent. Or payments to related parties may be held to be preferential and subject to clawback by a liquidator.
Good management
Putting aside the legal issues, complete and accurate records are essential for the sound and proper management of your business. It’s not possible to keep close track of your business’s performance and position without timely, accurate management accounts. Good records are the cornerstone of good financial management.
Budgeting
A three way profit, cash flow and balance sheet budget is an essential tool for businesses with large or fluctuating working capital needs, where cash flows are irregular or where the business operates on a small number of large contracts. It’s critical that cash needs be anticipated in advance and that borrowing facilities are adequate. A rolling 12 month profit budget will assist management work out whether the profitability of the company is up to a minimum benchmark level, and detect performance variations early, with a view to corrective action.
Bookkeeping
Most business people are too busy or lack the knowledge or skill to maintain their own books. In small businesses, the books may be updated irregularly and therefore lack usefulness to management. Or books may be up to date, but contain numerous errors. Or frequently, both!
Beware the untrained bookkeeper! We have seen many cases where a company’s books and records contain multiple, serious and long-term bookkeeping errors. Common errors include:
- failure to reconcile the bank account
- failure to provide the bookkeeper with sufficient information to correctly categorise and post bank transactions
- failure to reconcile loans between related entities
- incorrect treatment of capital expenditure
- failure to recognise or account for work in progress
- discrepancies between the general ledger balances of trade debtors and creditors, and the sum of the subsidiary (customer/supplier) balances
- failure to account for the sale, consumption of, or fall in value of various assets (eg prepayments, fixed assets); and
- failure to record a proper description of transactions to enable later audit or correction.
Some businesses end up paying their accountant tens of thousands of dollars to fix these errors. The lesson? We highly recommend the use of a competent bookkeeper. Don’t use your spouse to keep the books if they’re untrained – it’s false economy. The cost of professional bookkeeping is money well spent!
Don’t let a lack of accurate accounting records push your business toward insolvency.
You’re not sure what it costs to produce the goods and services that you sell
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Rules of thumb may underestimate your true production costs, leading to underquoting and inadequate gross margins.
Your customers may smile while you’re still in business – but if your business fails, they will be forced to obtain supply elsewhere at higher cost, more reflective of your industry’s true cost of production.
If you’re holding your prices low to be competitive (because ‘the market can’t bear a higher cost’) and as a result, you’re losing money, then you may be uncompetitive in your industry. Or your entire industry may be subject to competition or cost pressures that make it too difficult to earn a decent living.
We can review all of these issues and consider whether there are steps you can take to become competitive. If there are, then we can assist you to implement these changes, including the implementation of proper budgeting and costing systems.
Alternatively, we can assist develop a turnaround or exit strategy designed to minimise damage to all stakeholders.
Don’t continue running your business in the dark.
You need to retrench staff due to a downturn in the business, but can’t afford to pay their entitlements
If the answer is yes (and we can assist in a ‘future viability’ assessment) the preferred course may include sourcing finance facilities in conjunction with a Business Turnaround strategy. If the business seems destined to continue struggling after downsizing then an alternative strategy such as Small Business Restructuring or a Deed of Company Arrangement may be appropriate. At IRT Advisory, we have the experience to advise you in relation to all of these matters.
Always seek quality, professional advice when your business is struggling.
You believe you could trade out of trouble if only you could get creditors off your back for 12 months
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The problem is though, that many of your creditors are also running SME businesses and need to be paid. Some may give you latitude, but others will not be willing to wait.
Talk to us at an early stage about the potential solutions available through Small Business Restructuring or a Deed of Company Arrangement.
Something few SME business owners realise is that these solutions are available even before a business defaults on its debts. There need only be an apprehension of potential insolvency in the future.
SME business owners often worry about the cost of appointing an external administrator. One of the key things which increases the cost of an external administration is the level of investigation that the practitioner must perform as part of their duties. The fewer things that have gone wrong before the appointment, the less work the practitioner is required to do, and the lower costs will be. The moral is, act early and with integrity, before significant damage has occurred. If you do, outcomes will be better for all stakeholders.
If you see trouble brewing, don’t wait to explore options.
You need to restructure or sell the business, but you’re paralysed from taking action by fear of what is to come
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You may be losing sleep at night over the stress and worry of your company’s financial problems. This may be affecting your judgment and motivation to keep going. Perhaps you have been tempted to promise payment to a creditor by some date in the near future, without being confident of honouring that promise, just to get some short-term relief from the pressure.
Ultimately it may be beyond your emotional capacity to effectively deal with the mounting problems. Your suppliers may also be losing patience with you, if they have been promised payment and been let down.
Anger and frustration on their part, and embarrassment and worry on yours, is often not conducive to a rational and commercial negotiation and solution to the problems on foot.
As a third-party consultant with no emotional connection to your business, we can assist you to develop and implement the right strategies based on sound commercial principles, to ensure all stakeholders obtain the most beneficial outcome possible, at an economical cost.
Your first consultation with us is completely free of cost and obligation.
