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Managing Insolvency Risk and Checklist for Times of Crisis

Technological Advancements and Economic Growth

The breadth of technological change and digital disruption has changed businesses approach to managing insolvency risk. Innovation and risk taking can result in significant strategic benefit and growth but, clearly, may also be hugely detrimental to shareholders, creditors and stakeholders if things go wrong.

Objectively measuring and defining a company’s ‘risk appetite’ has become a critical factor for companies to include in their strategic processes. To underscore the importance of this, the ISO Risk definition has been changed – rather than “chance or probability of loss” it has now changed to “effect of uncertainty” and “risk based thinking”.

Calculated risk taking forms one of the most important factors in retaining a company’s competitive advantage. The concepts of decision-making and risk involve different dimensions.

Structured Approach to Business & Insolvency Risk for SME’s

At the Beginning

Prior to embarking on a new venture or project, directors will ideally have time to plan and prepare. Investigations, research, forecasts, benchmarking, costings, projections and situation analyses can be undertaken.
This “In Depth” approach is cyclic and any changes to the situation will require re-evaluation of the situation. When it comes to owning and operating a small business, don’t fall into the trap of the “Risk-Return” economic concept, where the greater risk should be associated with greater potential return.
Informed business owners know that good business practice and structure is also about de-risking where possible.

In the Middle

An established small to medium business should be well aware of specific hazards and the necessary controls to keep things on track as the organisation grows.
Quite simply, for small business this is adequately addressed by a combination of a structured business plan and documented operational procedures. Should these documents not be considered and in place as a business grows, it is likely that directors are blissfully unaware of all the risks and importantly how the business would best tackle a significant event.
Whilst the complexity of formal planning and documentation will vary between businesses, directors should broadly follow the process of identifying & assessing hazards, making decisions, implementing controls, obtaining continual feedback (from staff) and monitoring.

At the End

When it comes to managing insolvency risk, the most significant of all is “Crisis Management” as this is “Time Critical”. Failure to act immediately is usually terminal and very often, catastrophic. Unfortunately, it is virtually impossible to plan ahead as these are often the result of external forces that are beyond the directors immediate control.
A company that promotes a culture with a high degree of situational awareness is the most likely to survive in this scenario. This is where there is insufficient time for policies and manuals as the nature of disruption was unforeseeable, yet material in its impact.
This is where all available human, tangible and intangible resources are assessed and focussed on mitigating the identified threat.

Cash Flow Crisis – common insolvency risk for family businesses

Immediately upon recognising that your business faces (or may soon face) financial crisis, it is critical to seek professional advice from a Turnaround Practitioner as soon as possible.
Some of the actions that a reasonable business owner should take are included below. These steps are not exhaustive but they do serve as a useful checklist for the practical measures that can be undertaken immediately.
The overarching purpose of the checklist is to preserve the business’s position as much as is practicably reasonable – without impeding the business’s prospects of continued future trading. Quick decisive action on these points can ultimately prove fundamental to a building a successful recovery plan.

A) Security & Insurance

Ensure assets are adequately accounted for and adequately insured.
Ensure the physical security of company books and records (including computerised records).
Identify and carefully manage any individuals who may threaten the continuity of the business.
Identify creditors where trade terms have been breached and where renegotiation or alternate sources may be required.
Review all correspondence and list any letters of demand, enforcement actions, threats of repossession etc.
Do not despatch documents or goods with couriers or hauliers to whom you owe money.
Assess the disposition of financiers and consider whether a formal work out plan should be proactively presented.

B) Regulatory & Compliance

Accounting records are up to date and accurate for each reporting entity.
BAS lodgements are up to date.
Ensure all employee entitlements are paid on time.
Maintain all health and safety registers.
Obtain and secure all third-party agreements.
Ensure that all licences and registrations are up to date.

C) Director and Officer Conduct

Maintain adequate D&O (or Management Liability) insurance cover.
Do not incur any new debt or credit unless it is part of the turnaround plan that can reasonably likely lead to a better outcome (for example, where Safe Harbour is implemented).
Prepare a detailed rolling 100-day cash flow forecast (not a budget or income forecast, but a cash flow statement).
Obtain any landlord agreements and lease/hire purchase agreements. Consider any termination clauses (‘ipso facto’).
Prevent making any unfair preferences or uncommercial transactions (sale of assets/goods at an undervalue).
Document key decisions in written minutes.
Consider Grouping provisions (example) GST and Payroll Tax.
Act as fiduciary – in good faith and in the best interests of the company.
Check if personal guarantees have been given – to whom and by whom (bank, financiers, landlord, creditors, related parties, directors, shareholders). Consider the threat of preferences arising on clearing any personally guaranteed company debt.
Assess and establish Director Penalty exposure in relation to any unpaid tax debt. Has a Directors Penalty Notice (DPN) been received? What type of DPN is it?

D) Asset Protection

Ensure strict cash controls are in place and ensure no payments are made without director approval.
Update and ensure the accuracy of the fixed asset register. Consider creditor security interests under the PPSA 2009 (Cth).
Instigate a tactical collection method for your customer/debtors ledger to generate cash. Consider any rights for debtors to ‘set-off’ debt as they are also creditors.
Do not accept the delivery of goods unless documented and isolated from other stock (identifiable and labelled accordingly).
Conduct a stock take, identify and label equipment and make an assessment of ‘Work in Progress’ (current jobs, staging & progress payments, projects, contract, POs & enquiries or prospective orders).
Investigate and obtain formal valuations for assets (property, plant & equipment).
Identify any interest in the business or assets to date. Make a list of potential buyers who you believe may be interested but maintain complete confidentiality.
List sub-contractors who may be deemed to be employees – consider their unsecured creditor status.

Summary

Directors should not eliminate or reduce their risk-taking behaviour as it is crucial to innovation and success.

It is far more important to formulate a risk framework that is suitable for your company’s core business. Encouraging a culture of vigilance and awareness throughout the organisation can be a powerful aid in the management of your risk strategy.

It is of course, impossible to identify and accurately calculate every risk. What is important to remember, is that the immediate first actions taken in times of financial crisis will allow a Turnaround Practitioner to present a greater range of restructuring and turnaround options. Getting professional advice early is the best system for managing insolvency risk.