Indicators of failure for SMEs
Insights from a Liquidator
December 3, 2018
At HLB Mann Judd Insolvency WA, we handle a high volume of corporate insolvency appointments every year and from many different industries, so we are very familiar with inheriting business insolvencies in varying states of distress and despair.
Having said that, there are a few common symptoms that are consistent amongst the jobs we take on, particularly when it comes to liquidation work. If these symptoms are worked on, then one of your clients may never need to speak with ‘the accountants in the black suits’.
Human nature dictates that most directors would rather battle on despite mounting debts, more competition, lower margins and lot more risk, than face the music and ask for some help.
Too often we meet with directors and we say, ‘if only you had of come in to see us six months ago’, during times when, for example, the overdraft was operating within its limit, when the ATO was up to date, when your lease was due for renewal, or when you were yet to decide about taking on that long term, low margin, high risk contract to keep the cash rolling through the business.
By the time most people come to meet with us, the options to revitalise and restructure a business are virtually gone. The cash has dried up and the debts are too high to jump over. Or worse still, the director has exhausted all of their personal resources, and in addition to the business closing, the director ends up bankrupt personally too because of personal guarantees given to suppliers, landlords and finance companies.
Accountants need to recognise the indicators of financial distress in their clients early and take steps to reach out to us to talk about insolvency options. We would much rather act as the corporate doctor than the corporate undertaker. The sooner we can meet with people, the better – we can offer timely, accurate and customised guidance to directors, all within a confidential and understanding environment.
Read below about some of the indicators of financial distress that we see.
1. Inadequate and/or inaccurate books and records
Most jobs we take on either have a MYOB or Xero management accounting system. This is a good start, as we insolvency folk need to extract listings of creditors and to do this in an electronic environment is great.
But that is about where the good news ends.
Accountants will know that most clients do their best to run their management accounts correctly, but few get it right.
Accounting for GST and PAYG-w for example is seldom done properly, if at all, and often the Integrated Client Account bears no semblance to the balance sheet.
Work in progress is another area where clients, particularly those in construction and manufacturing, fall over when it comes to critical, timely accounting information.
Other areas of bookkeeping that lack accuracy are set out below:
• Lave liabilities
• Unpaid superannuation
• Hire purchases
• Director loan accounts, both credit and debit and sometimes both
It will not be surprising to hear that when financial distress sets in, directors tend to be distracted by day-to-day spot fires and ultimately take their eyes off the ball.
Therefore, a robust and accurate record keeping system is therefore critical to weathering the storm during tough times. If directors lose control of their accounts, it becomes a job of managing the GIGO principle – and that all becomes too hard eventually.
2. Not recognising the importance and value of a strong cash flow tool and budgeting
Cash is definitely king. When we trade on a company under voluntary administration for example, we are not focussed on the profit in a job or a contract, but how much cash it will produce and importantly – when it will come in.
We have seen profitable companies go broke because of a lack of cash flow. It is pretty rare, but it has happened before and it will happen again.
It seems pretty obvious, but directors need to understand the quantum and timings of both their cash inflows and outflows. A healthy balance sheet is great, but having debtors tied up for months on end does little to assist the business. Nor does a lack of awareness of the tax position of the business and timings of big future payments.
It still surprises us when directors do not budget for the inevitable Christmas shut down every year – not accounting for the lack of income, but just the same outgoings for four to six weeks.
When we meet with directors, we will ask them for a copy of their business cash flow – but few maintain one? Why is this?
One possibility is that the director is not savvy when it comes to the numbers of their business. We get that – and see it all the time. The director is great at winning jobs and delivering the product or service to the client. But the numbers? ‘I leave that to the accountant’, then often say.
Here’s some advice from us – assist your clients by setting them up with a simple and easy to use and maintain cash flow tool. Bringing in the added dimension of timing will assist your clients with managing their assets and liabilities more effectively and efficiently.
The advantages to your clients are obvious, and should a client ultimately end up in liquidation, a reliable, reasonable and accurate cash flow tool can be a useful defence to an insolvent trading claim from a Liquidator, if it can be demonstrated that the director relied on the cash flow tool when making decisions about whether or not to incur credit. But needless to say, the income area cannot include a line items titled ‘Future Lotto winnings…”.