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Control cash or face the law

POOR cash flow management can land company directors in jail. It is a crime for a company to trade while insolvent and a conviction can lead to a maximum penalty of up to five years in jail.

Recent examples of insolvent trading include criminal action taken against three Farmers Furniture directors. There is also a court case looming against embattled Carlton president John Elliot, which alleges his company Water Wheel traded while insolvent.

To avoid falling into the insolvency trap, businesses need to keep on top of their finances.

Ashton Read partner Clifford Rocke said companies could avoid insolvent trading by keeping a close eye on their financial statements and seeking professional advice.

“A lot of businesses only prepare financial statements for statutory purposes such as tax,” he said.

“Most managers don’t use financial tools to model their business. It can be as simple as knowing how much you have in assets and debtors that can be realised to meet your debts.

“Business proprietors should be in close contact with their accountants. They should be producing monthly statements to show what their actual figures are and comparing them to their projected figures.

“It’s not rocket science but, unfortunately, it comes at a cost – usually the accountant’s fee.

“However, by spending that money a manager or proprietor can be proactive about his or her business.

“There is also great computer software around at the moment, such as MYOB and Quicken, that can let the proprietor know how the business is travelling at any time.”

Mr Rocke said straying from the company’s core business was one of the main reasons companies ended up trading insolvent.

“Blue sky projects are one of the classic causes of insolvent trading. It’s where a proprietor decides to go off into a project that he or she thinks will offer great short-term returns,” he said.

“It usually involves something that is non-core to the main business and forces the proprietor to take his or her eye off the ball in terms of the core business.

“The trouble arises when the project fails. The proprietor goes back to the main business and finds that the debts have accumulated.”

Scottish Pacific Business Finance WA manager Vic Hardy said an obvious sign that a company was trading when insolvent came when it could not pay its bills.

“If the cash flow is not right then that is the start of your problems. Then you have an indication that the road ahead is likely to get a bit bumpy,” he said.

“But it can be solved. You have to identify why you are having cash flow problems. Are you living beyond your means or is it just a matter of timing and ingredients?

“Is your money tied up in debtors, for example? However, if your debts exceed your revenue, then you have a problem.”

Mr Hardy said one solution to cash flow problems was using cash flow lending products, such as factoring.

Factoring involves a company selling its debt book to a factor. The factor forwards usually between 80 per cent and 90 per cent of the debt book to the company and collects the debts.

Ernst & Young corporate finance partner Brian McMaster said in-solvent trading was a common problem but there were ways to avoid it.

“If you read the law, literally, virtually every company could be insolvent at some stage,” he said.

“If people are concerned in any way about the solvency of their company then they should seek professional help.

“The insolvent trading provisions were introduced into the law to try and prevent insolvent trading, but the trouble is directors are so scared of them that they don’t talk about it.

“It’s more of a cultural thing with Australians. I worked in the US and companies over there are much happier to put their hand up and seek help.”

Besides good cash flow management being good business practice, insolvent trading is a crime and company directors can be held person-

ally liable for debts if their company has been trading while insolvent.

Australian Securities and Investments Commission regional director Michael Gething said insolvent trading could attract either a civil or a criminal penalty.

If the criminal jurisdiction is chosen a company’s directors can face a $2,020 fine or five years in jail.

In the civil arena a person can be banned from operating as a director and face a pecuniary penalty of $200,000.

The penalty in either the civil or criminal jurisdictions is applied on top of any liabilities the directors may face from the collapse of their company.

Liquidators are required to make confidential reports to ASIC stating whether it is believed instances of insolvent trading occurred.

Mr Gething said ASIC applied insolvent trading in the criminal jurisdiction.

“If the liquidator suspects there has been insolvent trading and we think the case has legs, we will pursue it,” he said.

The liquidator can opt to pursue directors through the civil jurisdiction if ASIC declines to take criminal action.

However, in most cases liquidators choose not to do so because often it is not deemed worth spending creditors’ funds to pursue the action.

Mr McMaster said there were some defences a company could use against insolvent trading.

“One defence is to rely on a competent person to supply them with information that the company was solvent. However there is case law that is starting to define a ‘competent’ person,” he said.

“It’s alright to keep going and sail close to the wind if you have a realistic expectation of some funding coming in.”

Mr Rocke said the key test courts used to determine whether a company was trading while insolvent was to see if expenses outweighed revenue for a particular period.

“If the difference is marginal the courts may look to solve that through things such as the sale of non-core assets,” he said.

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