The Companies Act is very clear about the obligations to consider a potential Business Rescue for their Company by the Directors.
What does the Companies Act say?
Section 128(1)(f) of the Companies Act defines “financially distressed” as follows: (i) it appears to be reasonably unlikely that the company will be able to pay all of its debts as they become due and payable within the immediately ensuing six months, or (ii) it appears to be reasonably likely that the company will become insolvent within the immediately ensuing six months.
The Act goes further in Section 129(1) and states that the directors may resolve that the company voluntarily begin business rescue proceedings and place the company under supervision if the board has reasonable grounds to believe that (a) the company is financially distressed, and (b) there appears to be a reasonable prospect of rescuing the company.
Ok, but what does it mean?
Essentially these sections mean that the directors must determine whether the business is financially distressed. Thereafter they must determine whether there is a reasonable prospect of rescuing the business. If the answer to both questions is a “yes”, then Business Rescue is the way to go. The two definitions of financially distressed can be broken down into the following two concepts:
- Commercial insolvency. This refers to a business’s ability to pay its debts as they are incurred and become due for payments.
- Technical insolvency. This refers to a business’s balance sheet where the liabilities are valued more than the assets.
In terms of Section 129(7), if a company is financially distressed, but the board of directors do not wish to enter Business Rescue, then they must send out a notice to let the creditors know why they are not choosing business rescue.
Further to this, a company may file for business rescue if it sees that within the coming 6 months, it won’t be able to pay its debts as and when the creditors demand their payments. It is thus imperative for a business to use this process timeously to comply with the Act. Unfortunately, you have to do those cash flow projections you do not want to do. I know, we all hate it, but it is a necessity.
The practical signs and warnings to indicate financial distress:
So the question you are probably thinking of is – “the legal talk is great and all, but can we be practical for a bit? Can you give me a better idea of what I need to look out for?”. “When should I consider Business Rescue to assist my business?”
I often get these questions so I wrote this article. I hope it makes it easier for you to identify distress in your business. Businesses that are in financial distress generally have the following signs, red flags or indicators of their financial distress:
1. Unpaid debit orders:
Although this might be an issue related to timing, it can be an indicator of other issues. It happens so often that clients pay late or not as promised and then the debit orders bounce. This is life and part of business, but repetitive debit orders bouncing are an indicator of cash inflow shortages.
2. Letters from creditors to demand outstanding payments:
When a business receives letters from its creditors threatening that should they not pay the overdue account, legal actions will be taken. This is a clear indicator of financial distress if there is no argument about the amount being owed.
READ MORE: The Positives and Negatives of Business Rescue
3. Asset attachment orders:
Should the creditor obtain a judgement for their outstanding claim, then they can request the court to attach the assets of your business. If the court agrees with this, then the sheriff of the court will remove the assets of the business in order to pay the outstanding account. This is obviously not a good situation to be in.
4. Running at monthly operating losses:
This is probably the easiest way of determining whether your business will be to be financially distressed or not. Every month you should be checking your Management Accounts to determine the business’ profitability. If you see that you are running at a loss for more than a month, then your business could be in financial distress. If you are not checking your monthly Management Accounts, then please give Ernst a call and see how it is done.
5. Bank withdrawing credit facilities:
The banks will normally withdraw the credit facilities of the business if:
- it does not pay the monthly instalments, or
- does not pay the interest portion, or
- goes over the overdraft limit, or
- or the business stays in its overdraft for extended periods of time and never shows a positive cash flow.
Once a bank starts withdrawing its facilities, it is a clear indicator of financial distress and a shortage of cash flow.
6. Not being able to pay for stock or other services:
The moment you cannot pay for stock to put onto your shelves, or you cannot pay for the services to run your business, like telephone or rent, then the business is experiencing financial distress. Any business must have stock on its shelves, rent money, cash to pay other expenses and the like. If your business cannot pay some of these expenses, then it is experiencing financial distress.
7. Cash flow is tight and might be for the next 6 months:
Once you have your Management Accounts completed, it should be easy to perform a projection for the next 6 months. This is an easy check to determine whether the business will be able to pay its debts going forward. Remember, the Act states that should the business be fine for the next 5 months, but in month 6 you see that you might run into cash flow problems, then the board of directors must consider Business Rescue as an option.
READ MORE: Business Rescue, what is the actual aim of it?
8. Customer orders cannot be fulfilled:
This is a bad position to be in as well as heartbreaking. Although having customer orders and not being able to fulfil them is a “nice problem” to have, it is still a problem to solve. However, if it happens that your business struggles to fulfil customer orders every single month, then it is an indicator of other problems in the business and a possible red flag of not being profitable.
9. Employees are not paid in full every month or not on time:
Employees are the backbone and the foundation of all businesses. Without them, no business would be able to operate. Not being able to pay your employees on time every month is a clear indicator of financial distress and must be addressed with urgency. If it happens that your business cannot pay the employees on time every time, then you need to consider the causes of your business’s financial distress and sort it out with urgency. You cannot afford to lose your employees.
I hope this helped you to identify the indicators and red flags of financial distress. Once you are able to identify them, you can address the root cause of it immediately before it becomes a much bigger problem. Business Rescue assists you in addressing these issues while being granted the time to address it without fighting creditors in court or having your assets attached.
Talk to a Business Rescue Practitioner (BRP) instead of friends, family, or anyone with an opinion. Yes, the BRP will charge a deposit and the process will cost you money, but that could include legal advice, financial advice and advice in terms of the Business Rescue proceedings.
