Small businesses struggling to remain afloat amid rising insolvencies

The post-pandemic market has been challenging for small and medium-sized enterprises (SMEs) across Australia. While we like to think we are over the pandemic, the truth remains that the lingering effect of COVID-19 is continuing to unsettle the economic landscape, with an alarming rise in reported insolvencies. While the most common reason for business failure remained cashflow issues, almost 20% of all insolvent companies cited the pandemic as a contributing factor. 

Australia is not unique, however, with Financier Worldwide reporting: “Among the challenges have been market pressures in the form of evolving customer behaviour following the coronavirus (COVID-19) pandemic and the impact of competitors’ actions, as well as economic and political pressures, inflationary and cost-of-living rises, supply chain issues, tighter budgets and higher taxes”.

Closer to home, the latest data from the Australian Securities and Investments Commission (ASIC) paints a stark picture of smaller businesses’ difficulties, with insolvency rates climbing higher than those of larger organisations. 

The alarming statistics

Recent ASIC findings are a wake-up call for the SME sector. Small businesses are facing a disproportionate rate of insolvencies. More than three-quarters (82%) of insolvent companies in the last 12 months had fewer than 20 employees. Moreover, 83% of the insolvent companies had assets totaling $100,000 or less. And perhaps most alarming was that more than two-thirds of them (68%) had liabilities under $1 million. 

Mitch Ball. Source: Supplied.

The fallout has been severe for creditors, with almost all of them (96%) recovering a mere 0 to 11 cents for each dollar owed, according to ASIC.

The construction sector has seen the highest number of insolvencies (28%), with the accommodation and food services industry trailing at 15%.

Small business vulnerabilities

The data underscores a harsh reality: small businesses are struggling to stay afloat. With limited assets and thin margins, they are particularly susceptible to the economy’s ebbs and flows. 

Many businesses that took on substantial debt during periods of low interest rates are now vulnerable, grappling with unsustainable rising repayment demands and dwindling income as the government and central banks like the RBA aim to curb consumer expenditure by lifting interest rates.

The forecasts for the global economy in 2024-25 indicate only slight improvement, which implies that businesses will continue encountering hurdles related to high borrowing expenses and more stringent credit conditions, increasing the likelihood of defaults and bankruptcies. Once again, we expect SMEs to bear the brunt of these conditions, but larger organisations must also recognise they are not immune by virtue of size.

Concern for creditors

Creditors are facing significant losses, with most receiving nominal returns on their loans. This affects their bottom line and willingness to extend credit to small businesses in the future.

Sector-specific struggles

The construction, accommodation, and food services industries have been hit hard by insolvencies, reflecting broader challenges such as fluctuating demand, supply chain issues, and labour shortages.

The taxation time bomb

Many small businesses are increasing their reliance on unpaid tax and superannuation liabilities to support cash flow, a practice that has also caught the attention of the ATO. Jeremy Hirschhorn, the second commissioner, has highlighted the growing trend, signaling a clampdown on compliance in the upcoming year.

Mitigating the risks

In the face of these daunting statistics and the threat of heightened regulatory scrutiny, SMEs can adopt several measures to keep tabs on their financial health:

• Regular financial reviews: Conduct thorough and frequent reviews of financial statements to identify potential issues early.
• Cash flow management: Implement robust cash flow management strategies to ensure adequate liquidity.
• Professional advice: Seek advice from financial experts to navigate tax obligations and explore restructuring options if necessary.
• Diversification: Diversify client bases and revenue streams to reduce dependence on limited income sources.
• Operational efficiency: Streamline operations to cut costs without compromising quality or service delivery.

The rise in insolvencies amongst Australian small businesses calls for urgent attention and action. By understanding the challenges and implementing strategic measures, SMEs can navigate these turbulent times and emerge stronger. The road ahead may be fraught with obstacles, but with resilience and adaptability, small businesses can chart a course to stability and success.

Mitch Ball is the chief of insolvency operations and an ASIC-registered liquidator at Mackay Goodwin.