Lockton Monthly Macro Series: Insolvency Risks

We cover:

  • What’s driving the rise in insolvencies in 2022?

  • The business impacts of rising insolvencies.

  • What organisations need to be aware of heading into 2023.

  • Risk management actions organisations can take.

Insolvency overview:

Australian insolvencies are on the rise. Between 1st July 2022 and 31st October 2022, ASIC has recorded 2,393 insolvencies, compared to 1,418 for the same period last year. That’s a 69% increase.

What’s caused the increased insolvencies in 2022?

  • Cessation of pandemic related payments and support from the state and federal governments as well as government entities, such as the Australian Taxation Office.

  • Sharp rise in costs, compounded by shortages in materials and labour. In particular, the residential construction industry has seen several large firms enter into insolvency over the past year due to these pressures.

  • Persistently high inflation, and a swift increase in interest rates, have and will continue to add financial pressure on business margins, cash reserves, debt-servicing, and the ability to access new financing.

  • The Reserve Bank of Australia expects further increases in insolvencies in the period ahead as economic activity slows and vulnerable businesses draw down further on cash buffers.

  • The resumption of Australian Taxation Office enforcement activities on unpaid tax may cause some financially vulnerable businesses to commence formal insolvency procedures. Impacts of rising insolvencies:

  • Businesses trading on credit terms with their customers are now facing increased risk of slowing payments, or even nonpayment, of their invoices.

  • An increase in slowing payments, and non-payment of invoices, could lead to an erosion of profit margins, loss of revenue, potential cash-flow challenges, and the worst-case scenario; insolvency due to one or several bad debts.

  • Slow payments and bad debts may lead to disruption to day to-day activities, higher collection costs, growth constrains, and financial difficulties.

Risk management actions:

  • Businesses extending credit terms should have a documented process to identify, monitor, and manage their accounts receivable exposure. CRM can be as sophisticated as the business requires.

  • Credit checks should be conducted on all new customers and at least annually for all existing customers.

  • Take immediate action on overdue invoices and document correspondence. For time poor businesses, it may be best to engage an external debt collector to ensure maximum recovery.

  • Where applicable, a business should register its security interest on the National PPSR. The registration protects the interest in the goods or assets should the customer become insolvent or defaulted.

  • Trade Credit Insurance protects business by quickly reimbursing up to 90% of any domestic or export insured debt following insolvency or default, this may include pre-shipment credit risk for goods on delivery. TCI also provides monitoring and financial information about customers, knowledge of marketplaces, and debt collection services.

Looking ahead to 2023:

  • As COVID support is reduced or discontinued for many countries, insolvencies are forecasted to return to “normal.”

  • Australia is expected to see sharp increases in business failures, up by 49%.

  • Many markets may see an overcorrection due to a significant number of “zombie companies.”