According to the Reserve Bank of Australia, the share of companies entering insolvency has risen sharply over the past couple of years.
With economic indicators still weak for business, the RBA saw fit for a financial stability review into insolvency this month.
Here’s what the review found in terms of what makes businesses go insolvent and what other firms can learn.
Why does insolvency occur?
Unsurprisingly, poor economic conditions drive higher insolvency rates. However, firms citing economic conditions as a cause of their insolvency also cite other issues, like poor strategic management or financial control. The RBA’s report concludes that economic conditions could exacerbate underlying issues with a business’ model or management. Moreover, insolvencies usually follow an extended period of cashflow difficulty where a business is unable to repay debts.
Which businesses are going under?
Hospitality and construction businesses: According to the report, construction and hospitality businesses are the most likely to go insolvent. Ventures in these sectors usually operate with slimmer profit margins and limited cash buffers, making them more vulnerable to poor economic conditions.
Businesses with unsecured debt: Most companies that enter insolvency have unsecured debt – i.e. sums owed to suppliers, contractors and non-bank lenders.
Small businesses: More than three-quarters of recent insolvencies have been small businesses with under 20 employees. Generally this is because they are more vulnerable to challenging conditions.
Which businesses are recovering?
Small businesses are more likely to resume trade after an insolvency appointment, due to their small outstanding liabilities.
