Insolvent Trading – What is it and How to prevent it

Insolvent trading occurs when a company, already unable to repay debts as they fall due, continues incurring more debt. Engaging in insolvent trading is a serious offence and can result in serious penalties such as fines, jail time and directors becoming personally liable for company debts.

Often, it is challenging to determine whether a company is insolvent or is at risk of becoming insolvent. While some signs of insolvency are obvious, others can be far less obvious and can be a slow burn over time – more often collectively contributing to a business entering insolvency.

Below is a list of some common warning signs of insolvency, categorised into four groups.

  1. Financial Statement & Records Indicators
    • Continuing trade losses and diminishing / insufficient working capital
    • A lack or inability to produce timely and accurate financial information, including budgeting and strategic planning
    • Poor record keeping

2. Cash-Flow Indicators

    • Poor or no cash flow
    • Inability to collect debtors in a timely manner and bad debt write-offs
    • Overdue Commonwealth and State taxes, or long-outstanding taxes
    • Inability to pay staff wages or super
    • High and increasing gearing (debt to equity)
    • Making payments in rounded sums and for a minimum amount
    • A need to enter into payment arrangements with creditors
    • An inability to raise equity or loan capital, including from related parties
    • A reliance on external or related party funding rather than revenue generation from sales

3. Creditor Relationship & External Indicators

    • Suppliers demanding cash on delivery (COD) trading, or payments before supply
    • Creditors issuing demands or legal proceedings
    • Outstanding tax lodgements
    • A trend of losing customers / clients
    • Poor relationship with the bank, landlord, or key suppliers

4. Management & Internal Indicators

    • Director and / or shareholder disputes
    • High staff turnover
    • Denial, avoidance and ‘the blame game’ by directors and management
    • Poor upkeep of business premises and plant & equipment
    • A lack of corporate governance or poor compliance
    • Inability to invest in staff development, IT, and other business systems and processes

A business should rely on above-mentioned indicators to closely monitor its performance and to determine if urgent action is required to avoid insolvency. Seeking timely advice from trusted professionals and acting on the options available to deal with the company’s financial issues can be an effective strategy in preventing a forced winding-up.

 

Author

May Aung