SME Alert: Avoiding the pitfalls and liabilities of financial difficulty
This article focuses on the responsibilities of company directors, when the ‘health’ of the business is not great.
As advisors, there are often times where we are asked by the owners or directors to give our opinion on the financial ‘health’ of their business or company.
This most often occurs when the key financial indicators are all below budget, (if there are budgets) or suppliers accounts have piled up so high that days are spent reacting to angry suppliers who want to be paid. More correctly, and while the owner may not want to acknowledge it, let’s just call it ‘financial difficulty’.
This article concentrates on some key considerations and actions for company directors when faced with a company in ‘financial difficulty’.
The critical factor here is that directors face onerous personal liabilities if the company is experiencing financial difficulties. The overarching responsibility for the director is to recognise when a company is trading whilst insolvent, or approaching that position.
If the company is found to be trading while insolvent, the directors may be personally liable for certain debts and penalties and may be restricted from being a company director in the future.
A company is deemed to be insolvent when it cannot pay its debts when they fall due. Each year the directors must sign a solvency declaration when they file their Annual Statement with ASIC, which confirms (or otherwise) that the company can pay its debts as and when they fall due.
So, if a company is experiencing ‘financial difficulty’, or the directors suspect it might be getting close to insolvent trading, what should the directors do?
Three key actions to avoid ‘financial difficulty’
Directors should undertake these three key actions immediately:
- First and foremost, directors must avoid the ‘ostrich’ or ‘the head in the sand’ approach. Directors shouldn’t hold on to the belief that the financial position will simply ‘get better’ or that the business will be ok in a couple of weeks or months. What we can say, based on our experience, is that the problem is unlikely to go away without specific action by the directors.
- Directors must immediately focus on the financial mechanics of the company. In particular, directors should review bank accounts, current assets and current liabilities on a daily basis. This specific attention will most likely highlight one key failing in the company, i.e. the inability to produce timely and accurate financial information.
- Directors should meet promptly with their accountant to develop a strategy back to ‘financial health’. Directors of companies often believe that they have a solution for the financial hardship; they assume that they can simply lend (more) money to the company to alleviate the situation. This strategy invariably relies on either a second mortgage of the family home or a related asset sale. In all respects this is generally not a viable solution. Directors should also seek legal and specialist advice in conjunction with their accountant’s advice.
In recent years there has been a significant increase in the number of restructure and turnaround professionals in Australia, assisting hundreds of companies by developing plans that rectify the financial problems, and lead the company back into financial health.
One useful tool that is available for all directors to avoid ‘financial difficulty’ occurring is the Allan Hall Business Review. This review was developed specifically to target a range of aspects across the business so that once completed, the directors have a very clear view of specific areas they need to focus resources on to avoid a potentially nasty financial outcome.
If you would like to discuss any aspect of this article or the Allan Hall Business Review with us, please contact your Allan Hall advisor, or contact Simon Paterson at Allan Hall on 9981 2300.