The solvency or insolvency of a business is defined by whether its debts can be paid as and when they fall due. Whilst this distinction is clear, many directors tend to miss common early indicators of insolvency, this can lead to businesses trading whilst insolvent for extended periods of time and may incur serious personal liability. To better understand your financial situation, we have put together this list of the most common insolvency indicators.
Trade Losses and Cash Flow
If your business is seeing losses over a long period of time, this is a good early indication that you may be heading towards insolvency. This is usually seen in combination with a lack of cash flow stemming from poor trading or an inability to generate working capital.
Not Lodging or Paying Tax Liabilities
Typically allowing federal and state tax obligations to fall overdue is a way that some companies choose to deal with their cash flow issues. If there is an ongoing occurrence of this, or you have a large amount of liabilities not lodged. Then this is a good indicator your business may be heading for insolvency if it’s not insolvent already.
Legal Action is Taken Against the Company
If you have received multiple demands for payment, a statutory demand, or warnings from trade creditors threatening to stop supply, then this can indicate that creditors are having increasing doubts about the solvency of your company. If legal action is commenced, then a presumption of insolvency can be applied, however these payment demands are fair indicators of insolvency by themselves.
Keeping Inadequate Records
Keeping financial records that represent a true and balanced view of the company’s performance and position is a statutory requirement under the Corporations Act. If your business does not keep adequate records, you cannot accurately ascertain its true solvency. Additionally, in an administration or liquidation setting, a presumption of insolvency can be applied if adequate financial records are not kept.
Round Sum Payments and Special Arrangements
Special payment arrangements with your creditors can be a strong indicator of insolvency, especially when these arrangements are relied upon on an ongoing basis or are defaulted on. Round sum payments are also a general indicator of insolvency, mostly in cases where they cannot be reconciled to specific invoices or are a clear tactic to paying off large debts with small cash injections.
There are plenty of other early indicators of insolvency that business often miss in their day-to-day operations. While some are more serious than others, if you have any concerns about the health of your business you should contact us immediately to arrange an appointment. You can also take our free financial health check to gauge an estimate of the current solvency level of your business.