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Critical insolvency warning signs for SMEs in 2022 – Is it time to take action?

As Australia opens up to look at the “new normal”, many SMEs have been left blinking into the post-lockdown light, having spent the best part of the last two years struggling just to stay afloat.

SMEs have had to adapt to ever-shifting restrictions and legislative requirements throughout the pandemic. With borders and businesses open, a new set of challenges have emerged. 

Omicron changes prospects 

Despite the prospect of a bounce-back in the economy post-lockdown, Omicron has changed the playing field for businesses. Without certainty or reliability of staff, many SMEs have continued to struggle to meet their expenses and keep their doors open. 

Now, as the Omicron variant batters businesses, leaving them without staff or cash flow, it is more important than ever for decision-makers to understand, innovate and leverage their options to avoid a debt spiral.

Australian Bureau of Statistics (ABS) data from June 2021 revealed that up to 17 per cent of SMEs found it difficult or very difficult to meet their financial commitments over the following three months, particularly those in arts and recreation services, accommodation and food services, and retail trade.

UQ School of Law Associate Professor David Morrison, said, “Identifying the signs of insolvency and acting quickly is the first important step to avoid a spiral.” 

While government stimulus measures including multiple business grants and JobKeeper payments buffered businesses from catastrophic damage, the winding back of these measures may lead some SMEs to accumulate more debt.

Recognising the signs of insolvency

According to Judo Bank, an Australian bank focused on SMEs, around 160,000 of Australia’s 2 million SMEs are at risk of folding under the strain of the coronavirus crisis. Behind them, they would leave an estimated $40 billion in unproductive debt on the national balance sheet.

Cash flow issues are important signs a business is at risk of insolvency. Mr Morrison says past cases of insolvency law (regulated by government body ASIC) suggest the following are red flags:

  • Difficulty or inability to pay debts by deadlines.
  • Ceasing communication with stakeholders and creditors, including banks and the ATO, when debt obligations can’t be met.
  • Recording continual losses.
  • Negotiating deals with critical suppliers for earlier payment to ensure supply while other creditors are left waiting longer to be paid.
  • Inability to produce reconciled accounts to show a true financial position.
  • Erratic payment behaviour including drawing cheques or paying sums electronically in random amounts, usually rounded to tens of dollars; issuing payments that are not honoured; and promising payments but not delivering.
  • Receiving correspondence from creditors’ solicitors, letters of demand or judgement debt.

Supposing decision-makers suspect their company is in financial difficulty. In that case, the best step is to engage competent and proper accounting and legal advice as early as possible to increase the chance of the business surviving. 

A qualified liquidator can conduct a solvency review of the company and outline options, including refinancing, restructuring or changing the business’s activities, or appointing an external administrator. 

Pandemic changes insolvency laws

The Federal Government temporarily changed insolvency laws at the height of the pandemic in March 2020. The changes helped struggling businesses stave off worried creditors and protected company directors from being charged with insolvent trading. 

Following the temporary changes, the Federal Government announced new legislation, including some of the most significant changes to insolvency legislation in three decades; these changes are designed to assist small businesses in the insolvency process. 

The significant changes included:

  • New insolvency reforms that apply to incorporated small businesses with liabilities of less than $1 million.
  • Reforms include new debt restructuring and simplified liquidation processes.
  • The government is creating a new ‘class’ of registered liquidators who can only undertake debt restructuring. 

In the new normal of COVID, it will be critical for distressed businesses to have the necessary flexibility to restructure or wind down their operations in an orderly manner. 

SMEs at risk of insolvency or entering a debt spiral during the new normal of COVID should take advantage of the changes to insolvency legislation and professional help available to them. 

Read more about how to manage insolvency and burdening debt.

Read more: Treasury seeking feedback on insolvency law: How to have your say

Read more:Lockdown leniency over as the ATO resumes debt collection

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Heidi Heck

Heidi Heck

Heidi Heck is a Journalist at Dynamic Business. She is a student at the University of Queensland where she studies Journalism and Economics. Heidi has a passion for the stories of small business, as well as the bigger picture of economics.

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