Trading insolvent is a dirty word in business. The reality is, many of us run our businesses very close to the wind at times. There are many successful businesses who have struggled with cash flow at some point in their existence. Just having tight cash flow does not mean you are insolvent. However, because of your legal responsibilities, you need to understand when it’s time to get help, before it’s too late.



Trading Insolvent – What Does It Mean?

The definition for Trading Insolvent is similar in most of the world’s economies:

The business is unable to pay all its debts as and when they are due and payable.

It is not always simple to know exactly when a business should be declared insolvent. This is  why that’s a decision best made by an insolvency practitioner. As a business owner, company director or board member of a Not-for-Profit, your job is to know when you might be trading insolvent, so you know when to call in the cavalry. Your regular accountant is usually a good place to start for a referral but there are professional associations in most countries who can also help such as ARITA in Australia or R3 in the UK.

Seeking help can feel like a sign of failure but just burying your head in the sand won’t help either. A good insolvency advisor will work with you to ensure you come out of the process saving as much as you can. And the most important thing to save is your health!



Why Worry Now About Trading Insolvent?

While there are many positive aspects to our local, national and global economies, there are signs of turbulence affecting some sectors. Patrick Coghlan of Australia’s CreditorWatch says “Our Business Risk Index data showed a clear increase in external administrations across most industries, particularly in the latter half of FY23. Hospitality and construction were the two industries under the most pressure. Our forecast is for insolvencies to continue to rise in the first half of FY24.”

Director at Insolvency Australia, Gareth Gammon says now is the time for businesses to conduct a “health check” to prepare for the next few months and beyond. The advice he provides isn’t unexpected:

Ensure your books are in order and forecast your cashflow regularly.

“The risk of insolvency is decreased if this process is performed regularly. Preparing and analysing business cash flows and forecasts is optimal if performed monthly”, adds Ben Verney of Greyhouse Partners in the same article.

Review our warning signs to see if your business is approaching trouble. Our suggestions can help accounting professionals looking after their clients’ wellbeing.



Sign 1 – Your Cash Flow Forecast Goes Below Zero

When you run a cash flow forecast for the coming months, you want to see the bank balance each month above zero. Or, at least above your overdraft limit. If it drops below that level for a month or two and then goes back up, that does not mean you are insolvent. That indicates you have a short-term cash requirement and you need to act quickly to manage the shortfall. A few things you can consider here:

  1. Can you bring forward revenue?
  2. Maybe defer expenses?
  3. Consider borrowing extra to cover that period?

When your cash flow forecast shows a long and sustained period below zero and you have no easy means of rectifying that, that is when you could be heading towards trading insolvent. The sooner you get professional and experienced advice, the greater your chances of saving your business.



Sign 2 – Your Cash Reserves In Days Are Declining Rapidly

Cash Reserves in Days is a common KPI for cash management. It gives a good indication of the potential for your business to survive unexpected shocks. Didn’t 2020 shown us just how widespread those unexpected shocks can be? It compares your cash reserves to your average daily expenses. This is how to look at this KPI:

  • Greater than 90 days means you can generally relax (unless there is a pandemic…).
  • Many small businesses have figures closer to 30 days which is fine while everything is going well.

If your number is declining over time, it suggests your reserves are not keeping up with your expenses and there could be trouble in future. Time to seek help!



Sign 3 – Your Creditor Days Are Increasing

An increase in your average Creditor Days KPI is often a sign that you are having trouble paying your bills on time. A temporary blip may be nothing to worry about. Many businesses have seasonal crunches where it’s difficult to juggle the income and expenses for a short period of time.

However, it is a sustained increase in in your creditor days that should ring alarm bells. Remember that definition of insolvency above? It revolves around paying your debts when they are due. Now, we all know that businesses frequently stretch agreed terms by a few days.

The problems start when that becomes more than a few days and is applied to all or most of your suppliers. Then it is time to develop a plan.



Sign 4 – You Have Difficulty Borrowing

One solution to avoiding trading insolvent and the short-term cash shortage, is to borrow money. Banks are the most common source for this. But,  there are other lenders to small businesses who might be able to help.

However, if your bank is reluctant to extend an overdraft or give you a longer-term loan it might be a good time to get some advice on the long-term viability of your business. Speak to your accountant or advisor before it is too late.

Many of us have had experience with having to persuade bankers to lend us money when they’ve first said no. Just remember that they are looking at similar KPIs to the ones we’re discussing here and they see signs of trouble. If you want to be persuasive, you need to acknowledge the current situation and present a plan out of it. This needs to be something more than business as usual.

Beware of some of the high-interest business lenders that have popped up in recent years. Even though they may have close arrangements with your accounting software provider, examine the fine print of any loan they offer. Make sure to always ask for an APR (annual percentage rate). Some of them will quote you a simple interest amount that equates to an APR of 50% or more. That is not going to save you from insolvency. If you’re using Calxa, run the numbers through the loan wizard and it will show you the APR based on your expected monthly repayments.



Sign 5 – Cash flow Keeps You Awake At Night

Most of us accept it as a normal part of running a business that there are some times when we wake in the middle of the night worrying about our cash flow. That might be OK if it is infrequent. It is not OK if it’s constant. It will wear you down and that will reduce your ability to deal with the problem.

If cash flow is worrying you that much, it is a clear sign that you might be trading insolvent. Get some help and advice sooner rather than later and you will sleep soundly again.



Final Word on Trading Insolvent

To better understand where your fine line of trading insolvent is, start tracking some KPIs. Have a read of our 7 Important Business KPIs for Cash Management. This webinar recording KPIs for Cash Management has a demonstration on how to set this up in a reporting tool like Calxa. You can also use our Financial KPIs for Business Guide to get started.