With all businesses experiencing some degree of adversity, it can be difficult to realise if you are heading down the path towards insolvency. The problem often becomes more substantial when business owners choose to deal with the situation on their own and often end up nose-diving as a result. In order to take the appropriate steps to avoid disaster or know specifically when to ask for assistance, it’s important to know some of the common warning signs of insolvency. 

If you are currently going through financial hardships, these are some of the signs to look out for. Taking action at an early stage is essential and you should always enlist the help of professional commercial lawyers to receive actionable advice.

What exactly is insolvency? 

People use the term insolvency to describe a business that can longer pay its debts and are past their due date. Some individuals use the term interchangeably with bankruptcy, but insolvency is typically used in the context of business, whereas bankruptcy is used more often for a single person. 

A more formal definition of insolvency can be found under Section 95A of the Corporations Act 2001 (Cth): 

1. “A person is solvent if, and only if, the person is able to pay all the persons’ debts, as and when they become due and payable” and
2. “A person who is not solvent, is insolvent”

Although the legislation is clearly in place, the Courts have come to the conclusion that even when a company is unable to pay their debts by the time they are due, they are not necessarily classified as insolvent. In many cases, they could simply be temporarily lacking the funds to pay these debts, as a company may have little cash on hand to use. 

Common warning signs 

Now that we have an idea of what insolvency is, understanding the common warning signs of insolvency can help business owners to take the necessary steps to avoid liquidation. Here are a handful of these common warning signs to look out for: 

• Your business is making consistent losses 

Every business has its ups and downs, so making a loss for one quarter of the year is nothing at all to panic about. Despite this, you should be carefully analysing whether you are making consistent losses over time, with no real signs of improvement. This is usually the first warning sign that you’re heading towards insolvency. 

• Your business has failed at least two ATO payment arrangements in a small amount of time 

Acquiring a payment arrangement with the ATO can seem like quite a beneficial way to reduce some of the financial stresses on your business. However, if you fail to meet the agreed arrangement, then you may have to face the fact that your business has already entered into a state of insolvency.

• You aren’t able to meet upcoming BAS or superannuation payments 

PAYG Tax and superannuation payments are an essential part of running your business in Australia. If you are unable to meet the requirements for these payments, you may receive a Director Penalty Notice from the ATO that has the potential to make you personally liable to these payment debts. If you don’t lodge BAS or superannuation guarantee charge statements within 3 months of the due date, you automatically become personally liable for the PAYG Tax and the superannuation payments. 

• Changes in relationship with the bank 

Keep an eye on the relationship that your business has with the bank. If you see that they are monitoring your progress a little closer, check on the overall relationship that you have with them and if it seems to be degrading over time. 

• Staff Turnover

Businesses that need to make significant reductions in their employees in order to cover some of the costs of the business indicate that the organisation may be heading towards insolvency. 

• Formal payment plans

In order to safely secure an ongoing supply or to reduce the likelihood of legal enforcement, you may have to negotiate more formal payment plans. 

• Lending your business funds

If you’re noticing that you’re lending your company funds on a regular basis just to stay afloat, this could be an indicator that substantial financial issues are present in the business. It’s important to note here that if your company does not succeed, you may not be able to regain the money that you have lent it. In the event that you want to make a loan to the business, consult a professional business lawyer before making a decision. 

• Business records are unorganised 

Aside from being a general pain point for your business, another common sign of insolvency is when your business records are all over the place. If you noticed that you are unable to produce accurate financial statements, this is the time to reorganise these records with your accountant.

Why do people ignore these signs?

Despite experiencing some of these common warning signs, many businesses choose to ignore the fact that they may indeed be heading towards insolvency. Many people may not think there is a problem or are being too optimistic about things getting better down the track. For some business owners, their pride may get in the way and even if they know that there’s an issue, they’ll refuse to face up to it or take action against it. 

These are all dangerous paths to follow, so you should always make the first move as soon as you see some of these warning signs start to pop up in your business.

Taking the appropriate steps

The warning signs outlined in this article are by no means a definitive list, and you may experience a number of different factors. This is why we always recommend speaking to an experienced professional for the benefit of your business. Having a discussion with an insolvency lawyer when you are experiencing financial difficulties could be the difference between your business existing or liquidating down the line. 

DISCLAIMER: 

The contents of this blog are not intended to be sound substitutes for legal advice. You should not rely on this information as legal advice and instead should always speak to an accredited lawyer for professional advice on your situation.