Identifying indicators of insolvency or distress.

How can business owners and their advisors see the warning signs of a business in financial or operational distress? The latter aspect of the business operations under-performing or being insufficiently supported may be the key to a subsequent situation of financial distress. While the equation of company solvency is based on the ability to pay its debts when they fall due, the other numbers and behaviours in the business can be creating a dynamic that can imply that insolvency is on its way. This article looks at the common warning signs that a business could be in distress, which include:

  • Cash flow blocks

  • Stressed relationships with key suppliers

  • The ATO drama

  • Cogs in business operations spinning at different speeds

  • Leaders "checking out" or becoming overwhelmed

  • Bad vibes in the family

Cash flow blocks

Cash flow by nature should be described by any of its synonyms-move, swirl, cascade. Once stagnant (or drying up) and ponding around some rocks, it's clear there's a block to passing to another part of the business's ecosystem-to meet expenses.

Warning signs of business cash-flow issues include:

  • Negative operating cash flows.

  • Payments to suppliers and employees are higher than receipts from customers, so no nothing for overheads and deferred debts.

  • Delaying payments of creditors.

  • Continued trading losses and diminishing/insufficient working capital.

  • High and increasing gearing (debt to equity).

  • Deteriorating profitability or continuing trade losses.


Stressed relationships with key suppliers

Given suppliers are a mainstay of many businesses being able to deliver a product or service, the quality of relationships with suppliers is key to business performance. Once relationships with suppliers become stressed, the mess of that stress is likely to appear in the quality of product or service and then the customers' experience.

Warning signs of issues with suppliers include:

  • Regularly requesting suppliers to extend terms of trade.

  • Key supplier placing business on cash-on-delivery so 'shopping' around.

  • The original (and subsequent) suppliers remain unpaid for extended periods.


The ATO drama

The mere existence of a narrative around what the business needs to do (or perhaps not to do) in respect of its obligations and unpaid tax debt is a sign that the business is holistically compromised. Most of the time and for the best part of the business's history, its track record with the Australian Taxation Office (ATO) should be fairly unblemished. Yes, a late lodgement or payment is usually a constituent of the record. However, once a business is established, its model and reach are set, these obligations are predictable and a routine part of being in business. Once "the ATO drama" becomes a tale of long-outstanding taxes or broken commitments then the warning sign is clear: the business is in a fragile and possibly volatile position.


Cogs in business operations spinning at different speeds

As the cog-in-the-machine idiom alludes, the role of the mechanical cog is to have its teeth engage the teeth on the other cogs and is necessary to the movement of the whole machine. When one part of business operations starts to spin at different speeds, other parts of the business are invariably affected. While sometimes it appears harmless, it can reflect a systemic issue in the business.

Warning signs of breakdowns in procedures and internal controls include:

  • Records and bookkeeping not being kept up to date.

  • Financial reports are not prepared on timely basis.

  • Owners and management interfering with day-to-day operations.

  • Staff bypassing systems and protocols, either voluntarily or under direction.


Leaders "checking out" or becoming overwhelmed

We can all be forgiven for being burnt out or running low on energy and in desperate need of a holiday (or even a non-pandemic climate), a change of behaviour in senior leaders and managers in a business shouldn't be ignored. If the behaviour is demonstrating that someone is "checking out" it's time to reach out and find out what's underlying it. It may be a simple reflection of the company culture or standards needing to change, or perhaps it's in response to knowledge of a potential insolvency status, or an avoidance of any backlash in meeting role expectations and obligations.

Warning signs of management avoidance include:

  • Avoiding meetings or contact with suppliers, creditors, the bank, the ATO, accountants, advisors.

  • Not taking or returning calls or not reading mail/emails.

  • Avoiding/delaying making management or difficult decisions.

These are a just a few examples of what could be happening in this space. Any possibility of mental health being compromised must be handled appropriately and delicately. Fortunately, in this country we have many resources to assist and support people.

Understanding how chronic stress and business financial challenges affects people may be of interest to consider the other side of human nature at work.


Bad vibes in the family

Many businesses don't have a strong demarcation of relationships when family are working in the same business or it's a family-owned and -run business. Even those people who don't have their family or partner intertwined or invested in the business are faced the same challenge of being able to hide their work stress. When there's bad vibes in the family and strong family units start to disintegrate, it can be a clear warning sign of business in distress. Conversely, any stress at home can translate to stress at work. Hence the "checking out" element above.


Early assistance & intervention are key

Often businesses who display some, or all, of these signs are still salvageable. Early intervention usually equates to a happier ending. The key to being able to intervene early, whether that's as a business owner or as a trusted advisor, is to have an insolvency practitioner on hand to give a complimentary consultation that either gives reassurance that the business's health is fundamentally 'well' or offers unbiased advice and solutions.


In ASIC v Plymin (2003) 46 ACSR 126, the Judge referred to a checklist of 14 indicators of insolvency. Click here to download a copy.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.