Small Companies Fail Due to Cash Flow Problems, Debt Recovery Poor

As the new year (and a new decade!) rolls in, we soldier on hoping for a clearer outlook for 2020. Here at Slater Byrne, we look back at the debt recovery trends of the past year to help our clients assess the possible risks for 2020.

Inadequate cash flow remains the number one cause as to why small companies are failing across Australia, according to a report by the ASIC based on lodgments filed by external administrators.

Small Companies Fail Due to Cash Flow Problems, Debt Recovery Poor

Small Businesses Vulnerable to Failure

Those companies hiring less than five employees, followed by those companies hiring five to 19 employees, appear to be the most vulnerable, according to the report, which tallied lodgments made from July 2018 to July 2019. It should be noted that small businesses are vulnerable because they often cannot afford to put up a solid debt recovery system that will help them when their peers are also in insolvency.

Unsurprisingly, majority of the failed companies come from the following sectors:

  1. Business and Personal Services Sector,
  2. Construction Sector, and
  3. Accommodation and Food Services Sector.

Insolvent companies also come from the retail trade sector; the transport, postal, and warehousing sector; and the manufacturing sector. Other industries where many failed companies come from also include the rental, hiring and real estate services; information media and telecommunications; wholesale trade; electricity, gas, water and waste services; professional, scientific and technical services; agriculture, forestry and fishing; mining; health care and social assistance; and other financial services.

Cash Flow Problem Top Cause of Failure

Inadequate cash flow remains the top reason why businesses failed in 2019, according to external administrators. In fact, cash flow problems have been the number reason why businesses failed since 2016, basing on the ASIC report. Cash flow problems were prevalent in companies belonging to the manufacturing, wholesale trade, and accommodation and food services industries.

Aside from cash flow problems, other reasons companies became insolvent according to external administrators include:

  • poor strategic management, and
  • trading losses.

External administrators said many companies who failed because of poor strategic management come from the agriculture, forestry, and fishing sector, the rental, hiring and real estate services sector, and the transport, postal and warehousing sector. Companies who fail because of trading losses usually came from the manufacturing sector, accommodation and food services sector, and the retail trade sector. The external administrators also identified poor financial control, including lack of records, as a reason why companies fail.

Debt Recovery Measly at 11 Cents on Dollar

Company failures have a domino effect on the entire economy. It affects not just one business, but the community of businesses where the failed company thrived, or even an entire industry. Once a company is insolvent or in administration, it becomes more difficult for creditors to recover debts.

According to the ASIC report, in 96% of the lodged cases, the estimated debt recovery of unsecured creditors was less than 11 cents on the dollar – and this estimate has not improved since 2015. Most of the failed companies giving out less than 11 cents on the dollar to creditors belong to the retail trade sector; electricity, gas, water and waste services sector; accommodation and food services sector; and manufacturing sector.

Unsecured creditors of companies in the rental, hiring and real estate services; agriculture, forestry and fishing; and professional, scientific and technical services experienced better debt recoveries, according to the report. They received an estimated return of more than 50 cents in the dollar from failed companies.

Key Takeaways

The trend is that small businesses remain prone to incurring cash flow problems, leading to insolvencies. From the ASIC report, we can learn the following takeaways:

  • Small businesses should regularly review their clients’ credits, their clients’ directors’ guaranty, and their customers’ contact information.
  • Timely and proper invoicing is a cheap habit to form that could guarantee positive cash flows for any business.
  • The percentage of recovered debt in some industries are higher, but insolvency always makes it more difficult to recoup the actual amount.

Negative cash flows, however, can be resolved. We wrote here a financial checklist for business owners to improve their cash flows and avoid insolvencies. To add to that checklist, businesses should also take a more proactive role in keeping correct records, communicating with debtors, and sending out invoices.

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