Back to basics: Small business insolvency

Closed sign, hung on garage sign

According to ASIC figures, during February 2012 a record 1123 businesses were placed in administration. This is the highest single month on record, which highlights the difficult economic climate small business owners currently face.

Whilst the individual reasons for so many company failures will be varied, it is worth noting that even profitable businesses can go bust due to cashflow issues, tax debts or other unexpected circumstances such as a large debtor failing to pay their bill. In light of this, business owners should have knowledge of at least the basics of corporate insolvency, so they can protect themselves should anything go wrong.

The first thing every director should know is that they need to keep a track of their company’s financial position. Insolvent trading is illegal, and ignorance due to poor record keeping is no defence.

This means that if a business incurs debts whilst insolvent the directors can be held personally liable for debts incurred and may even face criminal charges. This can occur even if the director did not know the company was insolvent due to failing to keep records

Another issue that directors must be mindful of is tax debt. Many business owners aren’t aware that the tax office has the power to force their company into liquidation, but it is true that in certain cases, the ATO can do this in order to recover unpaid PAYG taxes. Usually, this will happen after several attempts at recovery, but it is important that business owners are aware of the risks if they owe money to the ATO.

For a director of a company that has an outstanding tax debt, there is the added pressure that the ATO can hold directors personally liable in certain situations where PAYG taxes remain unpaid, or where a company later goes into administration after paying a tax debt.

Whilst it is an issue that carries a certain amount of doom and gloom, it is important that business owners understand the risks. Hopefully, most business owners will never have to go through the difficulty of insolvency but if they do, they should seek expert advice as soon as possible.