Causes of Business Debt Distress

Even for a business in a relatively strong financial position, losses continuing over a significant period of time are not sustainable. While the cash flow shortfall arising from continuing losses may be offset for a period of time from existing capital, the sale of assets or financing activities (borrowing or raising further capital), none of these options are sustainable in the medium to long term. Continuing losses are a sure sign that debt distress is either present, or will follow unless corrective action is taken.

There are several liquidity ratios that may be used to assess the financial position of a business. Generally, ratios returning a value below 1 should trigger an immediate assessment of the financial circumstances of the business to determine how it will be able to keep operating in the longer term..

Current Ratio = Current Assets / Current Liabilities

Calculated by dividing current assets by current liabilities, this is the simplest ration to calculate. Caution should be exercised as often a greater proportion of current liabilities will be due quite soon compared to portion of current assets that will be able to be converted to cash in the same period.

Quick Ratio = (Cash + Accounts Receivables + Marketable Securities) / Current Liabilities

This is a harder test to satisfy. Most small businesses will not have any marketable securities so they are only comparing their cash and accounts receivable (debtors) against current liabilities. Where current liabilities are mostly accounts payable (trade creditors) and other obligations due to be paid in the next thirty days then this is the more appropriate ratio test.

Cash Ratio = (Cash + Marketable Securities) / Current Liabilities

This is the hardest liquidity ratio as for most businesses it is only comparing current cash at bank to current liabilities. This is the most appropriate ratio to apply where the accounts receivable (debtors) of the business are significantly overdue, heavily disputed or otherwise feared to be uncollectable.

Unpaid Australian Taxation Office (ATO) debt is a very common cause of the failure of companies and personally operated businesses. This may include Pay As You GO Withholding (PAYGW), Goods and Services Tax (GST) and Superannuation Guarantee Charge (SGC) arising from the late or non-payment of employee superannuation contributions.

Any company with unpaid Pay As You GO Withholding (PAYGW), Goods and Services Tax (GST) and/or Superannuation Guarantee Charge (SGC) should ensure that all monthly/quarterly ATO lodgements in relation to these are lodged on or before their dues date as a failure to do so can result in personal liability of the directors. In certain circumstances personal liability can arise even when these lodgements were made on time so any company with overdue ATO obligations should seek a preliminary review with us immediately. This ensure that the directors are aware of the personal liability that they may face in the future and how delaying taking action now may increase the liability amount.

If your bank holds concerns about your business or is not being fully supportive in relation to your finance facilities then that should be a driver to promptly seek expert advice. If your current bank has concerns then it is likely that any other reputable financier you approach will have similar concerns and may be reluctant to provide you with assistance.

This is the time to seek professional assistance as a failure to address your financial circumstances properly now may lead you at a later time, when circumstances are more desperate, to engage with a less reputable financier whose terms will be highly unfavourable compared to those that may be available in the early stages of financial difficulty.

If you have tried to seek alternative finance and been unsuccessful then it is possible that you are suffering from debt distress. This is because reputable financers would usually be keen to provide finance to any business that they had confidence in. This is a good yardstick to determine if professional intervention may be required.

Extreme caution should be applied to financiers seeking security (caveats, mortgages and guarantees) from outside the immediate ownership of the business. Parties such as parents, siblings, spouses, other family members and friends should never provide security for business loans except in the most exceptional circumstances. Any security or finance provided by such parties should never be for more than they are comfortably prepared to lose if things go wrong.

Most small businesses do not desire to sell further capital, which dilutes the existing ownership. Having said that, if there is a party expressing interest in buying part of the business who then loses interest once they see the financial information about the company that is a sign that an independent person considers the company may be in financial distress. A lack of interest by independent parties in getting involved with a company, or providing finance to same, should be taken as a sign that a review of the

Being placed on COD by a creditor due to an overdue account, or being required to make catch up payments in order to ensure continued or the resumption of supply, is a significant indicator that a business is facing debt distress.

Prompt action needs be taken at this point to ensure that appropriate arrangements are made with all critical suppliers. A failure to do so raises the risk of the business being unable to obtain goods and services which are necessary for its continued operation

If you are unable pay creditors within trading terms it will likely not be long before creditors cease supplying your business. If this happens with a critical key supplier it may become impossible to continue to trade. Further, your failure to pay may be advised to credit reporting agencies, particularly if you operate in certain industries.

Being unable to creditors within trading terms is one of the earliest signs of debt distress and should be ignored. Many businesses fail simply because instead of seeking professional advise and taking effective action when they reached this point they delayed taking steps until financial affairs of the business were at a point that it was impossible to recover from.

Although cheques are rarely used these days, issuing post-dated cheques or having to take similar steps, for example making promises to pay, or using extended credit to purchase items that were previously paid for by cash or short term credit is often an early warning sign of debt distress or impending insolvency.

Any business that needs to extend payment timing beyond the usual periods needs to have a very clear understanding of the financial position of the business, why these steps are necessary and what is going to happen to get the timing of payments back within terms.

Needing to make special arrangements with selected creditors is a frequent early warning sign of debt distress. While this can be a valid strategy in the right circumstances, great care must be taken to ensure there is an effective plan in place to move beyond this scenario in the shortest time possible.

Demands for unpaid debts are a signal of severe debt distress, and likely insolvency. Urgent professional advice should be urgently sought at any time that a business’ financial circumstances are such that its creditor have been unpaid for such a length of time that creditors are in the process of preparing for or commencing litigation.

Payments of rounded sums is a frequent sign of a business suffering from debt distress. It is often adopted as a way to keep sending money to creditors to gradually pay off a larger overdue amount. An inability to pay creditors debts as and when they fall due should be taken as a sign that professional assistance needs to be sought as a matter of urgency.

Payments of rounded sums is a frequent sign of a business suffering from debt distress. It is often adopted as a way to keep sending money to creditors to gradually pay off a larger overdue amount. An inability to pay creditors debts as and when they fall due should be taken as a sign that professional assistance needs to be sought as a matter of urgency.