When a business encounters cash flow difficulties and an excessive debt burden, it is important to navigate these challenges carefully. Trading while insolvent not only jeopardises the future of your business but also exposes you to legal exposure. Here are several actions to avoid and some proactive solutions to consider.
What Not to Do:
1. Preferential Treatment of Suppliers with Personal Guarantees:
o Avoid prioritizing payments to unsecured creditors and suppliers who have personal guarantees. This practice can be deemed as giving unfair preference, which can deemed voidable and can be reversed by a liquidator and/or court if the company enters liquidation. It is essential to treat all suppliers fairly and equally to avoid legal repercussions.
2. Increasing Exposure to Creditors:
o Do not increase your debt burden by taking on more credit card debt or extending your trade accounts. This can worsen your financial situation and create a false sense of security. Instead, focus on reducing expenses and finding ways to increase revenue without accruing additional debt.
3. Accepting Deposits for Services/Orders You Cannot Fulfil:
o Refrain from taking deposits from customers if you know you cannot meet the commitment. This can be found to be a breach of a directors duties. This practice is considered fraudulent trading and can lead to severe legal consequences. Always be transparent with your customers about your capacity to deliver.
4. Repaying and Preferring Intercompany Debt and Unsecured Shareholder Loans:
o Avoid repaying intercompany debts, related party debt or unsecured shareholder loans over other creditors. This can be seen as preferential treatment and can be challenged by liquidators and in court during insolvency proceedings. Ensure all creditor payments are handled impartially and consider the entitlement of creditors (secured/preferential/unsecured).
5. Ignoring Creditor Entitlements:
o Do not disregard the entitlements of creditors. Secured, unsecured, and preferential creditors have specific rights under the seventh schedule of the Companies Act 1993 that need to be respected. Ignoring these entitlements can lead to legal actions and further financial complications.
Risks of Trading Insolvently:
Trading while insolvent can have serious implications:
• Legal Risks: Directors may face personal liability for the company's debts if found guilty of wrongful or fraudulent trading.
• Reputational Damage: Insolvency proceedings can harm your business's reputation, making it harder to rebuild trust with suppliers, customers, and investors.
• Financial Penalties: Insolvent trading can result in seeking contributions from directors and in severe cases or repeat cases, disqualification from acting as a director.
Proactive Solutions to consider:
1. Debt Management:
o Negotiate with Creditors: Open lines of communication with your creditors to renegotiate payment terms. Many creditors would prefer to work out a repayment plan than see your business go under. Consider a company compromise under the Companies Act 1993 to gain time to pay and possibly some relief (with requisite creditor approval).
o Debt Restructuring: Consider restructuring your debt to extend payment periods, reduce interest rates, or convert debt into equity.
2. Inventory Control:
o Optimize Inventory Levels: Implement inventory management systems to avoid overstocking or stockouts (short on key stock items). This can free up cash tied in inventory and reduce storage costs.
o Just-In-Time (JIT) Inventory: consider adopting JIT inventory practices to minimize holding costs and reduce waste.
3. Invoice Management:
o Speed Up Collections: Implement strict credit control policies to ensure timely collection of receivables. Consider offering early payment discounts to encourage quicker payments from customers.
o Factoring and Invoice Financing: Use factoring or invoice financing to get immediate cash flow by selling your receivables to a third party.
o Issue your invoices in a timely manner
4. Cost Reduction:
o Cut Non-Essential Expenses: Review your expenses and cut non-essential costs. Focus on maintaining expenditures that directly contribute to revenue generation.
o Outsource Non-Core Functions: Consider outsourcing non-core business functions to reduce overhead costs.
5. Increase Revenue:
o Diversify Income Streams: Explore new markets, products, or services to increase revenue. Diversifying can help cushion against downturns in specific areas of your business.
o Boost Marketing Efforts: Increase your marketing efforts to attract new customers and retain existing ones. A targeted marketing strategy can lead to higher sales and improved cash flow.
Conclusion
Facing cash flow difficulties and an excessive debt burden can be overwhelming. However, by avoiding the pitfalls of preferential payments, increasing debt exposure, and trading insolvently, you can protect your business from legal and financial troubles. Implementing proactive solutions such as debt management, inventory control, and invoice management can help stabilize your business and pave the way for recovery. There are also options to discuss with an insolvency practitioner that can help save a viable business such as voluntary administration and company compromise. Always seek professional advice to navigate these challenges effectively and ensure compliance with legal obligations.