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.

The start of the year can be a challenging time for many business owners, especially after the extended break over the Christmas and New Year period. The pressure is compounded by the need to settle various financial obligations, from employee holiday pay to tax payments.

Many businesses are facing the strain from having paid employees holiday pay entitlements, a period where income has not been generated due to closure and then obligations such as November GST due 15 January, Paye due on 22 January, Oct to Dec FBT due on 22 January, provisional tax due on 15 January and for the larger employers more PAYE due on 5th of February. Some are now struggling with the reality that these obligations are overdue.

Managing cash flow during this period is critical, and proactive steps can make a significant difference. We explore strategies to handle the cash crunch, options for arranging instalment plans with Inland Revenue, and the point at which seeking professional advice from a Licensed Insolvency Practitioner becomes necessary.

1. Assess Your Cash Flow: Begin by conducting a thorough assessment of your cash flow. Understand your current financial position, taking into account outstanding invoices, upcoming expenses, and the various tax obligations due in January and February. This knowledge forms the basis for creating a realistic plan to navigate through the financial challenges.

2. Prioritize Expenses: Identify and prioritize essential expenses. This may involve distinguishing between critical operational costs and discretionary spending. By focusing on what's necessary for day-to-day operations, you can allocate funds strategically and ensure that vital aspects of your business are not compromised.

3. Communicate with Creditors: Open and honest communication with creditors is key. If you foresee difficulties meeting payment deadlines, approach your creditors early to discuss your situation. Some may be willing to negotiate payment terms or provide temporary relief. Establishing transparent communication builds trust and can lead to more favourable arrangements.

4. Explore Inland Revenue Instalment Plans: Inland Revenue understands the challenges businesses face, especially during the post-holiday period. If you're struggling to meet your tax obligations, consider reaching out to them to discuss instalment plans. Inland Revenue is often open to working with businesses to find a manageable repayment schedule.

5. Seek Professional Financial Advice: For some businesses, the financial strain may become overwhelming, and navigating complex tax obligations may seem daunting. In such cases, seeking professional financial advice is crucial. Engage with a financial advisor who can provide personalized guidance tailored to your business's unique circumstances.

6. When to Contact a Licensed Insolvency Practitioner: If your financial situation continues to worsen, and you find it impossible to meet your obligations, it may be time to consult a Licensed Insolvency Practitioner. Insolvency specialists can assess your business's viability, explore restructuring options, or guide you through the insolvency process if necessary. Early intervention increases the likelihood of finding a viable solution and reduces the prospects of being held liable for trading insolvently.

Starting the year on a financially sound note is essential for the success of any business. By proactively managing cash flow, communicating with creditors, and exploring available options with Inland Revenue, business owners can navigate the post-holiday cash crunch successfully. When faced with insurmountable challenges, seeking professional advice from a Licensed Insolvency Practitioner is a responsible and strategic decision to protect the long-term interests of your business. Remember, there are resources and professionals available to help you weather the storm and emerge stronger on the other side. Contact This email address is being protected from spambots. You need JavaScript enabled to view it. for more information.

Voluntary liquidation allows a company to terminate its operations and sell off assets and for any shortfall to be dealt with.

Some companies are liquidated because they serve no further purpose. Some are liquidated as they have unfeasible operations or poor operating conditions or technology has moved on. Others are liquidated because the founder has retired or passed and the business cannot operate without that expertise. Some have been affected by the failure of a large customer, the loss of a major contract or an extraordinary event, like Covid-19. 

Most companies advance an insolvent liquidation because:

• The business cannot pay its debts as and when they fall due.
• Liabilities exceed total assets.
• The business is making losses and there are minimal prospects to turn it around.
• The directors are finding it hard to cope with the stress and pressure of trading.
• Trading is in decline and there is concern of personal liability for trading insolvently
• The directors would like someone else to deal with the creditors and all their claims.

Struggling companies juggle the payment of debts, are often in receipt of formal demands or statutory demands and commonly are on instalment plans with Inland Revenue or certain suppliers that they are having difficulty honouring.

When a company is facing financial distress and having trouble paying its creditors including GST and PAYE, there is a high chance that the business is already insolvent. Company directors who operate an insolvent business must act in the best interests of creditors and cease trading immediately if there is no realistic prospect of recovering from the financial difficulties being experienced.

When a company is in too much in debt to recover from a turnaround strategy or restructuring procedures such as company compromises or voluntary administration, liquidation is often the only viable course of action.

Liquidating leads to dissolving the failed company structure and bringing all activity of that company to a close. It is a way for a company that has run out of funds to deal with the shortfall to creditors.

What is the role of the liquidator?

The role of the liquidator in an insolvent liquidation is essentially to realise the company's assets, and, where possible, to make a distribution to the creditors.

The liquidator also conducts investigations into the failure of the company, the conduct of its directors and, sometimes the conduct of third parties, like creditors.

What steps do you take if your limited liability company has no future?

An insolvent company is generally wound up voluntarily by the shareholders or on a Court application by a creditor. A licensed insolvency practitioner (IP) is appointed to oversee the liquidation process.

The liquidators take steps to realise the company assets and pay outstanding creditors according to a designated hierarchy set out in the Companies Act 1993. If there is a shortfall the creditors receive their entitlement and the balance is written off or possibly pursued under a personal guarantee if one has been granted.

If the company has sufficient funds to pay all creditors, it is solvent and surplus funds are distributed among shareholders according to their percentage shareholding.

If the company is solvent, the company can be wound up following a S218(1)(d) strike off process or by way of a solvent liquidation process. The latter can provide more certainty for companies with larger capital gains.

Why would you initiate liquidation voluntarily?

The process of voluntary liquidation is less stressful than facing a winding up proceeding following a creditors application to the Court. The voluntary appointment can be planned in advance to minimise disruption and the shareholders have the opportunity to select the licensed insolvency practitioner who will manage the entire process. The appointment process is fairly straightforward.

Liquidation may not necessarily mean the end of the business. It may be that the business assets are sold at market value as a going concern and a new company takes over. The IP decides on the best way to maximise value for the creditors and whether that involves closing or trading whilst the business is marketed for sale. With a voluntary process the plan can be discussed prior to the appointment including how staff are managed and assets realised. Often directors can have an involvement or a say in the process because it is in their interests to maximise the recovery and minimise the exposure to creditors who hold personal guarantees.

What are the risks of trading an insolvent company?

Although a company structure provides limited liability, this does not mean directors can ignore matters if financial problems arise. Directors have legal obligations to adhere to certain standards. Acting earlier reduces the risk of personal liability.
Continuing to trade with knowledge of insolvency is a risk, where you could find yourself as a director being held personally liable for trading.

Once a director or shareholder knows their company to be insolvent, they must not engage in any activity which could worsen the position of creditors or increase their losses any further. Directors should not increase debt, incur further credit, dispose of assets below market value, or increase their overdrawn current account.

If you do not have sufficient funds to pay everyone you owe, you place your creditors at risk of receiving a voidable transaction if they have knowledge of the demise of your company.

What steps do you take if your limited liability company is in financial difficulty but you have a viable business?

If your limited liability company is facing financial distress but the business is viable, gain advice from a professional. A licensed insolvency practitioner will be able to talk you through the options for rescuing the company (restructuring), giving you the best chance of a successful turnaround, while also ensuring you are adhering to your duties as a director.

There are options such as a hive down process (new company structure), creditor compromises (current company structure with a repayment plan for creditors), voluntary administration (current company with a Deed of Company Arrangement).  

For advice, contact the MVP team.

Benjamin Franklin said, “There are only two certainties in life – death and taxes”. Whilst failure to pay the second shouldn’t lead to the first, it can cause significant problems for individuals, as outlined in a recent Court decision.

Nicola Joy Dargie was sentenced to two years six months imprisonment for failing to pay PAYE deducted from employees’ salary to the IRD.

Ms Dargie’s explanation for the non-payment of $740,000, which occurred over a period of 10 years, was that she had withheld the tax payments from the IRD to keep her employees in a job.

It is a practice that we encounter on a reasonably regular basis in liquidations - directors using the amounts they have deducted from their employees’ wages for things such as PAYE, Kiwisaver, Child Support and Student Loans, to boost the cashflow of their business. Their priority being to keep suppliers paid so they can continue to employ staff.

There are several problems with this course of action.

First and foremost, the funds are not the directors, or the company’s, to spend. They are the employees’ funds deducted from their wage entitlement for specific purposes and should be held in trust.

Secondly, there can be severe penalties imposed on directors who follow this course, as evidenced by the sentence imposed on Ms Dargie.

Thirdly, even if the intention was that the payments would be withheld for only a short time, to get through a tough trading period for example, the penalties and interest charged by the IRD for non-payment are at such a level that it does not make economic sense to do it. It would be better (and safer) to go to the bank for a short-term loan.

By continuing to operate a business that is not able to pay its debts, including taxes, as they fall due, directors expose themselves to potential claims against them personally that they have breached their duties as directors by trading whilst insolvent.

The amounts deducted from employees’ wages, and, to a similar degree, the GST collected on sales, are not funds available to a company to cover operating expenses and pay trade suppliers. These funds should be put into a separate account and only accessed to pay to the IRD as they fall due.

If directors find themselves in the position of having to dip into those funds to pay other expenses, then they need to review the financial position of the company to assess its on-going viability.

If you are in arrears with PAYE you are in a far better position if you consult with IRD and reach an instalment plan on arrears. If hardship applies, then notify IRD early on. If the company is insolvent, consult an accredited insolvency practitioner.

If you would like more information or advice on managing tax payments and the solvency of your business, please contact one of the team at McDonald Vague.

Effective cashflow management is critical to any businesses survival and growth. Understanding your businesses underlying cashflows will help identify potential changes to your business processes that will improve cashflow, profitability and business value

A firm's ability to reliably spin-off positive cashflows from the firm's routine business operations is one of the key factors business owners and potential investors look for.

Cashflow Defined

Cashflow is typically defined as the net change in your firm’s cash position from one accounting period to the next. If you generate more cash than you consume, you have a positive cashflow. If you have greater cash outflows than inflow, you have a negative cashflow. Thus, your cashflow is a key indicator of a firm’s financial health.

Understanding Your Cashflow Statement

Operating cashflows illuminate a company's true profitability. It's one of the purest measures of cash sources and the use of cash within a business and is the launching pad for complementary financial statements and reports.

Operating cashflow is a fundamental part of your cashflow statement. Your cashflow statement illustrates the fluctuations in cash compared to less volatile equivalents such as shareholders' equity and the balance sheet.

Your cashflow statement details both where cash is being generated and consumed in the business over a set period of time.

By taking the net income figure from the firm’s income statement and adjusting it to display variations in the firm’s working capital defined as payables, receivables and inventories as reflected on the balance sheet, the firm’s operating cashflow line item illustrates the sources of cash spun off during the reporting period.

Cashflow Sources

A business’ sources and uses of cash are typically split into categories covering operations, investments and financing activities.

1. Operations: Reflects a firm's operational cash inflows and outflows, the net effect of these defines a firm’s operating cashflow position
2. Investments: Shows changes in the businesses’ cash position from the divestment or acquisition of property, plant and equipment or other typically longer-term investments
3. Finance: Captures changes in cash levels from the share buyback schemes or bond issues, together with interest payments and dividend distributions to shareholders.

Operating Activities

A firm’s operating activities comprise its routine core commercial activities within the business that generates cash inflows and outflows. These operating activities typically include:

1. Sale of goods and services recorded during an accounting period
2. Supplier payments covering goods and services consumed during the production of outputs recorded during an accounting period
3. Employee payments or other expenses incurred during an accounting period.

To establish the significance of underlying material changes in a firm’s operating cashflows, it is useful to be familiar with just how a firm’s cashflow is estimated. Two models are generally used to tally cashflow generated by operating activities. These are the Indirect and Direct models.

Direct Method: Uses information derived from the income statement based on cash receipts and cash outgoings generated by the businesses’ operations.

Indirect Method: Adopts the firm’s net income and derives its OCF by incorporating those line items used to determine the firm’s net income but which did not affect the firm’s actual cash position.

Operating Cashflows

Your operating cashflow is a very useful assessment tool as it assists business owners to understand the firm’s fundamentals. For many owners, the OCF position is considered to be the cash component of net income, as it purges the firm’s income statement of non-cash related items and non-cash based expenditure such as amortization and depreciation and changes to the firm’s current assets and liabilities position.

Operating cashflows is a more accurate indicator of underlying profitability than measures of net income, as it is less open to massaging the operating cashflows to window dress profitability.

Cashflow As A Business Diagnostic

A cashflow statement is much more than simply a snapshot of your business’ financial health. They can also be used as a powerful management tool to affect positive change within your organisation.

Business owners can use a cashflow statement to evaluate their firm’s strengths and weaknesses, helping them to chart a savvy and more efficient path forward. Used the right way, a cashflow statement can show an owner how efficiently the business is harnessing its cash while identifying which areas are absorbing more cash than they generate.

This information can be critical to ensuring the firm’s survival while providing a point of focus for growth initiatives. Cashflow is also a useful indicator of how efficient an internal business process is and how dynamic a firm’s products or services are.

By identifying changes to a firm’s internal business processes that will improve the firm’s underlying cashflow, profit, and business value, a business owner can drive innovation, lift productivity and effectiveness levels and cull under-performing products.

When a firm enjoys robust operating cashflows with more cashflowing in than flowing out, the owners know they have a healthy business. Companies with solid operating cashflow growth are more likely to enjoy predictable net income levels, together with an enhanced ability to pay suppliers and reinvest in the business.

Robust operating cashflow also provides more opportunities to expand the business and to cope with fluctuating economic conditions, turbulence in their industry or adverse weather events.

Final Observation

A firm’s operating cashflow is simply one aspect of a firm's cashflow position. Cashflow is also one of the most insightful measures of a firm’s financial viability, underlying profitability and its long-term prospective outlook. Cashflow measures a company’s incoming and outgoing cashflows over a nominated accounting period. Cashflow is also a useful tool for identifying inefficient processes and under-performing products or services. If you truly identify with the "Cash is King," mantra, then robust operating cashflow is one of the most reliable key indicators to look for when assessing a firm.