The Red Flags of Financial Distress
- Arnold Shields
- Apr 4, 2011
- 3 min read
Updated: Jun 13
As forensic accountants, one of our core roles is identifying financial distress in a business. Signs of distress are often evident from a review of the financial statements. But pinpointing when a business shifts from financial difficulty into insolvency—that critical tipping point—is far more complex.
Why does this matter? Because the moment a business becomes insolvent is the moment directors can become personally liable for company debts. This timing also becomes a key issue in disputes, liquidations, and litigation.
What Is Insolvency?
The most commonly accepted definition in Australia is straightforward:
A business is solvent if it can pay all of its debts, as and when they fall due.
This means that insolvency is not just about whether a business owes more than it owns. It’s a forward-looking test, can the business meet its liabilities in the future, as they come due?
The Net Asset Test Is Not Enough
While a traditional balance sheet review might reveal a negative net asset position, this alone is not sufficient to prove insolvency.
Even a business with ongoing losses and liabilities that exceed its assets is not necessarily insolvent if it can continue meeting debts on time. This is why the timing of obligations—not just their existence—is crucial.
Complicating Factors in Assessing Solvency
Several commercial realities can cloud the picture:
Non-enforcement of payment terms: A supplier might have 30-day terms on paper but allow 60 or 90 days in practice.
Director support: A director might personally fund the business, masking its inability to obtain finance from third parties.
Informal creditor arrangements: Unofficial repayment terms may be in place that do not appear in the formal records.
Red Flags That May Suggest Insolvent Trading
Here are common indicators that a business may be trading while insolvent:
Ongoing trading losses
Liquidity ratios below 1 (current liabilities exceed current assets)
Unpaid tax debts (e.g. ATO, superannuation)
Deteriorating relationships with lenders
No viable source of external finance
Inability to raise fresh equity
Suppliers switching to cash-on-delivery (COD)
Persistent overdue payables (long creditor days)
Post-dated or dishonoured cheques
Selective payments to certain creditors
Legal action, judgment debts, or solicitor letters
Inconsistent payments not linked to invoices
Missing or incomplete financial records
Delays in preparing or lodging financial statements
Each Case Is Unique
Insolvency is a question of fact. There is no one-size-fits-all rule, and every business must be assessed individually. That’s where forensic accounting steps in, to investigate, document, and provide expert opinion on the financial position and timing of insolvency.
If you suspect a business may be insolvent, or are involved in a dispute where insolvency is an issue, our team can assist with a detailed forensic review and expert reporting.
Need Expert Insolvency Analysis?
Dolman Bateman has decades of experience in forensic accounting and litigation support. Get in touch to discuss how we can help.
Disclaimer:
The information provided in this article is general in nature and does not constitute personal financial, legal or tax advice. While every effort has been made to ensure the accuracy of this content at the time of publication, tax laws and regulations may change, and individual circumstances vary. Dolman Bateman accepts no responsibility or liability for any loss or damage incurred as a result of acting on or relying upon any of the information contained herein. You should seek professional advice tailored to your specific situation before making any financial or tax decision.
