Regardless of the business structure, a lot of business is done by people dealing with people and the relationship between the parties will dictate how business is conducted. Strained relationships often lead to or come from a strained business. Business owners can get an indication of the health of their business from the health of their relationships with the people they do business with.
Poor relationship with Bank
Banks have a distinct advantage over other creditors. The bank knows what funds are on hand and can assess and analyze the flow of funds through the account. Business owners will have had to provide financial information to borrow money, and the bank can demand further information at any time. None of this information is usually available to ordinary suppliers.
A poor relationship with a bank usually stems from:
- not paying monies due to the bank;
- placing the bank in a position where it regularly dishonors payments; or
- providing financial information which is wrong, misleading or fanciful.
A poor relationship might simply result from the bank’s assessment that the business is not well managed or financially weak.
A poor relationship with a bank does not prove insolvency, just as a good relationship does not prove solvency. The bank may be amongst the last to know of a customer’s insolvency because the customer has operated within agreed limits with the bank while “borrowing” heavily from trade suppliers and the tax department.
Certainly if a bank has seen a customer’s financial information and refuses to advance further funds or calls up a loan or overdraft, the reasons for that action need to be established. Banks very rarely act without proper cause and, although a poor relationship with a bank may be the result of other factors, it usually is the result of the bank’s lack of confidence in the business, and particularly its solvency.
The bank is generally a business’s main source of funding, and if that avenue has closed a cash poor business will immediately have to consider its solvency.
Suppliers demanding COD trading, or payments before supply
Individual creditors are the first to know that their invoices are not being paid. An efficient credit manager or business operator will have systems in place to identify overdue accounts and prompt remedial action.
Remedial action may involve only supplying goods or services to the debtor on a COD basis. Placing a customer on COD says that the supplier has no faith in the customer’s ability to meet future commitments. Some creditors go further and only re-supply when they receive part payment of the old debt as well as payment for the new supply. They are effectively saying that they do not believe that they will be paid the old debt in the near future.
In instances where a range of suppliers are overdue and some of the suppliers have limited supply to a COD basis there are either cash flow problems or the debtor is insolvent. Business owners have to determine whether there is a realistic short term end to the problem and whether creditors can be brought up to date. Many do not give this much thought.
An enterprise that has a range of creditors with accounts outside of agreed terms must be considered at a high risk of being insolvent, and that conclusion is usually justified.
Creditors issuing demand or proceedings
A single letter of demand from a creditor is not proof of insolvency as there may be a real dispute between the parties that allows the debt to remain unpaid until resolved. Cash flow may also be delayed for a legitimate reason and payment may have been delayed longer than the creditor thought reasonable.
By the time the creditor has instructed a solicitor to write a letter of demand, the business owner will have to determine whether that legitimate reason is really legitimate or not.
A series of demands from a number of solicitors should create a strong presumption of insolvency. It would be an unusual business that has a large number of disputes with a number of suppliers all at the same time, particularly if these disputes are not satisfied in the short term.
Clearly if the creditor moves beyond the demand stage and obtains a judgment the presumption of insolvency is all but confirmed unless the judgment debt can be paid immediately. When execution of the judgment by way of a warrant is undertaken by the creditor or a statutory demand expires insolvency is certain.
How long can a cash flow problem last before it becomes a case of insolvency? A shortage of funds can only be described as ‘short-term’ if it is certain that problem will be overcome in the short term.
Placing a time period on overcoming the problem is difficult as some cash flow problems may be seasonal or caused by specific contractual problems. We are unaware of any judicial pronouncements on the topic. However, as a general rule, we would expect that short-term cash flow problems should be solved with all creditors being brought up to date within a period of three to four months.
If business owners cannot form a realistic plan to achieve that goal, they have to start planning for the likelihood that the business is insolvent.