Insolvency has been a hot topic over the past year or so, with spectacular collapses across various industries, the return to pre-COVID levels of insolvency appointments and a significant rise in recovery actions by the ATO. These developments suggest that insolvency will remain a hot topic in the year ahead – one that should be discussed, not dismissed!

ASIC has recently added to that by releasing two updated guides for company directors: Regulatory Guide RG217 Duty to prevent insolvent trading: Guide for Directors, as well as Information Sheet 42 Insolvency for Directors. You can access both these papers here: RG 217 Duty to prevent insolvent trading: Guide for directors | ASIC and Insolvency for directors | ASIC.

So, what exactly is insolvency?

In simple terms, insolvency is the inability to meet your liabilities as and when they fall due. “It’s more of a cash flow test than an asset -over-liabilities test – it’s about a business’s working capital and its ability to meet its obligations in the normal course of operations”.

There are a number of factors to take into account when assessing whether a company is insolvent.
• What are the usual trading terms?
• Is there a pattern of financial distress?
• Is the business able to borrow funds if needed?
• And can it quickly turn assets into cash if needed?

The list is quite comprehensive and often depends on the specific circumstances of the company. In many cases, experts may need to be involved to undertake a forensic review and analyse the company’s exact solvency.

While it’s always preferable to avoid insolvency if possible – as the consequences are never pleasant for any of the stakeholders – occasionally it may be an outcome that is not able to be avoided. For instance, a large claim that is made against a company that is not able to be covered by insurance or paid out through lack of sufficient funds.

The COVID pandemic is a good example of businesses facing the threat of unplanned or even unimagined events that had a detrimental impact on them. However, in most cases, insolvency is a gradual process that develops over time, usually because of the inability of the business to restructure itself or deal with the threats. Or even more importantly for the directors to understand their financial position in an even more complicated environment.

So, what are the consequences of insolvency?

You will have obvious consequences such as inability to pay your liabilities, or the need to terminate staff (often without notice!), or the simple failure of the business and its inability to keep operating. There are also personal consequences – especially where there may be personal guarantees in place that get called on, potentially leading to the bankruptcy of the individuals.

But there are also less obvious consequences such as reputational risk, adverse credit ratings, personal cashflow issues, limited capacity to borrow – and even action by ASIC itself if directors commit offences or are otherwise deemed to be unfit to act as directors. Added to this are the emotional consequences and the often-resultant breakdown in relationships.

But can you avoid insolvency?

Well, yes, but generally this involves a good understanding of the company’s position, as well as being on top of all things financial on a very regular basis. To be frank, preparing your accounts for year-end tax returns 8 months after year end, doesn’t really cut it here!

Ongoing solvency is an issue that management needs to monitor regularly – at least quarterly, and preferably monthly. This doesn’t have to be overly complicated – just a report that addresses the assets available to meet the current obligations would suffice for most purposes or some cashflow analysis monthly would also assist.

Some of our favourite tips for avoiding insolvency include:
• Create a Realistic Budget – what should happen, not necessary what you want to happen!
• Monitor Cash Flow – watch out for upcoming large payments that need to be funded
• Build an Emergency Fund – whether for capital expenditure, or for upcoming taxes, it’s always helpful to have some funds aside to ease cash flow pressure
• Manage Debt Wisely – avoid taking on more than you can handle, especially at higher interest rates
• Diversify Income Sources – for example, reduce reliance and risk by not relying on a few key customers
• Stay Informed – keep up with industry trends and economic changes that might affect your business.
• Review and Adjust Regularly – be proactive and willing to make changes as necessary – even if that’s outside your comfort zone!
• Prioritise Profitability – keep evaluating products and services to make sure they are both competitive and profitable
• Seek Professional Advice – a qualified and impartial opinion is helpful – having a second set of eyes running over the information can bring valuable insights and help you make informed decisions.

Implementing these tips can help solidify your financial standing and reduce the risk of insolvency. Generally, you need to understand your financial position at all times.

The articles prepared by ASIC are directed towards company owners and directors and are very comprehensive and useful. However, if you want to discuss aspects that directly relate to YOU and YOUR business, it makes sense to speak to a professional in that area.

We at dVT Group encourage business owners and managers to contact us for a no-obligation and confidential discussion to see if we can assist. Please contact one of our experienced team at dVT Group on (02) 9633 3333 or by email mail@dvtgroup.com.au.

dVT Group is a business advisory firm that specialises in business turnaround, insolvency (both corporate and personal), business valuations and business strategy support.

Suelen McCallum
January 2025