How do I know if my business has real cash flow problems?

JIM DOWNEY from JP Downey & Co has the answers.

“How do I know if my company has real cash flow problems?”

Jim Downey answers: Most businesses experience occasional cash flow problems, but it is not normal to be in a permanent state of financial stress. If your business regularly experiences one or more of the following problems then it could be in trouble:

• Creditors go unpaid for more than 90 days.
• Banks regularly dishonour business cheques.
• Creditors refuse supply or insist upon cash-on-delivery arrangements.
• Post-dated cheques are regularly used to settle accounts.
• BAS statements are regularly lodged late with the tax office or BAS payments are often in arrears.
• Employees’ superannuation is not paid or is badly in arrears.

If one or more of these are true of your company, there is a strong possibility that it is insolvent.

What is insolvency?

The definition of solvency is the ability of a company to pay all of its debts as and when they fall due. If it is unable to do so, it is insolvent.

Directors of an insolvent company have a positive duty to act. If your business regularly displays one or more of the above trouble signs it would be advisable to seek urgent advice from a qualified professional – either a lawyer with experience in the area, or an insolvency practitioner. The Insolvency Practitioners’ Association of Australia (www.ipaa.com.au) can assist in finding a member in your vicinity.

What should I do if I suspect my one of my customers is insolvent?

Warning signs that a customer may be insolvent include:

• Slow payment (more than 90 days).
• Dishonouring of cheques.
• Sudden urgent orders for goods outside of credit terms.
• Prevalent industry gossip that a business is in trouble.

If you are providing goods, you should consider incorporating a reservation of title clause on your invoices to permit you to recover any unsold stock should the customer go into liquidation. Your lawyer will be able to draft a suitable clause for you.

If you are providing services, however, this is not an option; you should be careful not to allow the debt to amount to a sum that would cripple your business in the event that it could not be repaid.

The golden rule is that it is better to say no and risk losing the customer than to allow your credit terms to stretch so far that your whole business may be compromised should the worst occur.

Remember, promises are cheap, but it is cash that really makes the difference.

What happens if my business trades while insolvent?

The law deals with this issue with a “carrot and stick” approach.

The carrot the law offers is that if you are in trouble you have the ability to appoint a voluntary administrator, and independent professional, to assist the company and its creditors to maximise the outcome for all concerned, either by winding up the company in a timely manner, or striking a deal with creditors that allows the company to return to normal trading.

If you don’t avail yourself of this carrot, the law hits you with a big stick. If you are the director of a business found to have incurred debts while insolvent then the liquidator or the creditors may sue you personally for the debt. Generally, this is a civil action requiring a lower standard of proof and therefore more likely to succeed against you.

So beware. If your business is showing signs of insolvency, act early and decisively or suffer the penalty.

Jim Downey is principal of JP Downey & Co, an accounting firm specialising in insolvency and business reconstruction. With more than 20 years’ experience in the insolvency area, Jim is a senior member of the accounting profession. He has advised thousands of businesses on how to avoid or recover from insolvency.