Is your business insolvent because of COVID-19? What to do next (for small and medium-sized business)

Estimated reading time: 12 minutes Business survival

Business owners need to be realistic about the collectability of invoices and be ruthless with cutting expenses to deal with a potential economic depression. They also need to look to the future and pivot their business strategy because the world has changed.

Is your business insolvent because of COVID-19? What to do next (for SMEs)

In article:


  • During the COVID-19 economic crisis, small-to-medium sized businesses (SMEs – businesses with less than 200 employees) need to move with the tide of the economy instead of resisting it. It is likely that many businesses will do the opposite – this crisis may be a time when the oaks are blown over while the reeds survive.
  • The first step is to look at the parts of your business that are changing and predict how COVID-19 will accelerate change, then assertively downsize to prepare for the worst scenario that you can predict. There is the prospect of an economic depression unfolding in Australia (or at least a deep recession) followed by a slow recovery.
  • Downsizing involves terminating non-performing staff, over-priced suppliers and clients that do not match your target client model.

Grim financial reality is a massive drop in sales and the timeframe for recovery is unknown

Proverb: The best time to plant a tree was 20 years ago. The second best time is today.

At the time of writing, there is no generally accepted empirical model for how much economic activity has slowed as a result of COVID-19. Although it is accepted that there will be a significant recession and high unemployment, we do not know if there will be an economic depression. An economic depression may be defined as a decline in GDP of more than 10% or a recession that lasts more than 2 years. This is the first time in a long time that Australia has faced a real risk of depression.

Business owners need to make an educated bet that considers whether Australia faces either a recession or a depression in their forward planning. This means planning for both scenarios and acting today to prepare for either occurring.

Australia has not suffered a recession in almost three decades and it has not had a depression in almost one hundred years. Therefore, business owners should assume that no one is qualified to advise them (based upon acquired knowledge or personal experience) about exact steps that should be taken in a depression scenario. This is especially the case if the professional adviser has primarily been trained in providing services to large corporates and is ‘green’ in advising small-to-medium sized enterprises (SMEs).

Business owners will need to make their own evaluation about how long recovery will take for their industry and their clients. The only parallel in history that we have is the Spanish Flu pandemic which lasted from 1918 until 1922 (where the virus recurred in three distinct waves). There is a risk that business owners will significantly underestimate the time period for economic recovery.

Your accountant has never been through this before. A band-aid solution (such as using tax credits and loans) and waiting for a recovery may not be enough to save your business.

Listen to Ben Sewell interviewed for the Tax Talks podcast on the COVID-19 changes to insolvency law.

Formal insolvency appointment is on hold

Proverb: Conquerors are kings; the beaten are bandits.

Our system of insolvency is not fit to deal with a depression, so the Federal Government took extraordinary measures to allow insolvent businesses to continue to trade (without being legally required to appoint an insolvency practitioner).

If you would like to read more about the extraordinary measures to suspend the prohibition on insolvent trading please read our blog post:

Hit pause on appointing a voluntary administrator during COVID-19

The key takeaway is that even if the business is insolvent, the owners have 6 months to reorganise their business operations and restructure before a formal appointment (voluntary administration or liquidation) is legally mandated.

Move with the economy not against it

Proverb: No wind, no waves.

When a business is approaching insolvency, SME business owners tend to make poor decisions because they don’t deal with root causes quickly. Poor cash flow is a lagging indicator and business owners should benchmark business performance and honestly evaluate their own management capability.

With 20/20 hindsight, most directors of liquidated companies will tell you that they would have been more decisive if they had their time again (read: cut deep earlier). Instead, they made poor management decisions and did not develop a strategy. Directors complain about how they spend their time putting out fires without noticing that the fires were growing, not subsiding.

Directors may also be entrepreneurs and so they are naturally optimistic. In this case they should build into their forward planning a ‘worse case’ scenario that takes into account an economic depression. In that scenario (contrary to national economic interests) the business should be downsized.

The various incentives to maintain overhead burdens that the Federal Government is offering do not change business fundamentals. Tax credits and loans provide a temporary remedy but if the business fundamentals have changed, the business owners will end up under pressure to make payroll and repay loans. A deferral strategy is a poor one for an insolvent business to adopt.

Immediate bookkeeping write-up

Proverb: If you don’t measure it, you can’t manage it.

Getting a complete bookkeeping write-up in MYOB or Xero will give you up-to-date financial information to work with. It is also essential to file tax returns to obtain the benefit of the tax credits that the Federal Government is automatically applying to your running balance.

Businesses have income and expenses – both need to be carefully reviewed.

On the income side, it will be impossible to collect debts during COVID-19. Under the Coronavirus Economic Response Act, creditors will not be able to issue statutory demands for debts less than $20,000 and the compliance dates for statutory demands will change from 21 days to 6 months. Business owners should realistically assess their debtor ledger and apply tight payment terms to all clients (i.e. COD or termination for non-payment). If decisive action isn’t taken it is reasonable to assume that a lot of invoices will need to be torn up at the end of the COVID-19 crisis.

A line-by-line expense review is also essential and all non-essential items should be carefully reconsidered. If your house is burning down what are you going to keep?

The takeaway is that all of the announced Federal Government incentives are temporary and will not cure fundamental viability problems an insolvent business has. A complete bookkeeping write-up and review is essential.

Terminate non-performing staff

Proverb: Don’t build a new ship out of old wood.

If your business faces insolvency, then employees who are not performing or are detrimental to workplace productivity should be terminated. This will free up your management time and the employees that remain will get a boost. This is another example of where standing down staff (and deferring decision-making) may make the financial position of the business worse and send the wrong signal to your high performing employees. If you terminate staff, do not do it slowly – do it once at the beginning of the economic crisis.

Terminate overpriced suppliers

As a result of the Federal Government measures set out in the Coronavirus Economic Response Act, your company’s creditors will not be able to enforce debts against you. This is intended to facilitate debt hibernation but at some point in time this debt will again be enforceable. What this does provide is an opportunity to terminate suppliers who are not optimal without an immediate concern about enforcement action. It is foreseeable that this may also give the business an opportunity to renegotiate terms on a more favourable basis.

Be careful not to engage in unethical behaviour – it will send the wrong signal to your employees and essential suppliers (who won’t trust you anymore either). If you explain your financial position to your suppliers with respect and forthrightness you may be surprised to find that they support you going forward.

Takeaway: Businesses that cut costs radically today will have the best chance of outlasting those that don’t take action.

Terminate clients that don’t match your target – who is your ideal client?

Proverb: Take a second look; it costs you nothing.

If your business has stopped dead, this is the perfect time to look at your marketing strategy. One strategic marketing framework that is useful is to fully describe your ‘ideal client’. This forces the business owner to think about the characteristics of their ideal client and then move the business closer to attracting that client. At such a critical time, the first characteristic that is essential is that all clients should have capacity-to-pay.

The ‘ideal client’ analysis also helps businesses to realistically evaluate what they need to do to segment the market further. It is also likely to lead to the conclusion that most of the business’ profit comes from a small number of current clients (i.e. a derivative of the Pareto Principle or the 80/20 rule). Therefore, the termination of 80% of the business’ clients (to give a rough estimation) will free up working capital and increase the profitability of the high-quality 20%.

Takeaway: Why not liberate yourself of the clients that give you a headache after COVID-19 when they might not pay you anyway?

Be careful of expensive loans

Proverb: Good economy makes men independent.

If the business is no longer profitable, then a business loan will only provide temporary relief. It may provide working capital that will be spent on overheads that are no longer sustainable.

High interest business loans such as receivables financing, credit cards and hire purchase agreements should be the last resort. No interest loans provided by friends, fools and family may destroy personal relationships down the track.

Business loans should only be sought if the business owner has a cash flow forecast and is prepared to use the money strategically. The SME loan guarantee scheme also requires that business owners/directors personally guarantee at least half of the loan – so if the loan cannot be repaid, they may face personal insolvency or a loss of personal assets.

Takeaway: Do not borrow money if you haven’t planned how it will be used – it may be better to go into liquidation and then start a new company than to incur more personally guaranteed debt for an insolvent business.

Make predictions about how your business will change after the recovery

Proverb: Judgment delayed is judgment avoided.

No one really knows whether we will face a recession or a depression. If we look at history, the closest parallel is the Spanish Flu pandemic of 1918-1922.

People are being forced to work from home, there is significant media hysteria and there are massive economic changes going on. Business owners now have the difficult task of betting their future on what they predict will occur in their industry. It is clear that no professional advisers have been through anything like this, so they may not be able to help business owners.

What is clear is that the ‘disruption’ of your business practices that are driven by competition and technology will accelerate – possibly to warp speed. One example is Courts – if Courts can run online why do barristers think they will be able to charge full day rates for sitting around at Court all day? If barristers bet that their practice will return to normal after Courts run successfully online they may make a serious strategic mistake.

Don’t invest in sunset technologies, work practices or pricing strategies – embrace the changes.

Preserve cash position

Proverb: Time is money.

There is a growing view in Australia that people may stop paying their debts. The National Cabinet has committed to stopping landlords evicting tenants and business-to-business debts cannot be effectively enforced through statutory demands. If this is the case, business owners should carefully consider appropriate strategies to preserve their cash position.

If there is a whiplash on debt recovery at the end of COVID-19 you will be better placed to negotiate debt settlements if you have good liquidity.

Takeaway: Cash will always be king.

Pivot where necessary rather than waiting for recovery

Proverb: Tomorrow never comes.

No one knows how long it will take for the economy to recover from COVID-19. However, we do know that it certainly won’t be fast enough to save many insolvent businesses. Therefore, business owners should carefully consider whether to pivot their strategy rather than face a slow death. A slow death would involve borrowing money, paying overheads that don’t produce a return and ignoring changes in the market.

The best strategy will always be to chase the highest value opportunities and to do this, the business owner needs to be connected to their customers and their competitors.

Takeaway: Look to the future while others hibernate.

Restructuring during safe harbour may be optimal rather than waiting for recovery

Proverb: It is at times useless to mend a sinking boat in the middle of the sea.

Directors should seek professional advice about restructuring during the safe harbour to make sure that it is feasible and legal. Asset values are likely to be severely affected so it may be unlikely that a business owner can obtain a fair price for a sale to third parties.

Restructuring options include:

Unfortunately, business owners need to understand that voluntary administration is very unlikely to give them a debt holiday and it is not fit for purpose for most SMEs.

On the other hand, there have recently been stricter civil and criminal laws made to stop illegal phoenix activity. Transferring assets out of an insolvent company without legal advice at the 11th hour is not a good idea and it may give an incoming liquidator a claim against directors or recipients of the assets. If you want to learn more about phoenix activity read our blog post: The Complete Guide to Illegal Phoenix Activity

Key takeaways

  • You may have noticed the proverbs included in this opinion piece – these stimulate creativity, and dealing with a strategy challenge will require you to be creative
  • Business owners need to be realistic about the collectability of invoices and be ruthless with cutting expenses to deal with a potential economic depression
  • Business owners need to look to the future and pivot their business strategy because the world has changed


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