This report is asked by the supervisor of Turnaround and Insolvency Business Experts or TIBE which is a famous insolvency and restructuring firm to assess the insolvency status of its client Deluxe and Delicious Wine Pty Ltd or DDW. This company is involved in the business of wine with the service extended to the field of warehousing and distribution. Present business scenario of this company had put them in some tight corners related to their financial conditions and they are facing problem towards management of creditors. The CEO of the company had come to TIBE to seek help to come out of this situation with the activities of critically assess the financial condition of the company as per the legislative rules imposed by the Corporation Act, 2001 of Australia. The CEO was looking for the suggestions and advice from TIBE in order to know the options available for the company if it is placed under the supervision of external administration along with her next course of action being CEO in this situation. To assess the case, the company has handed over a file with confidentiality which possessed the financial information of relevance and by researching that information, inference is to be drawn in the form of suggestion by TIBE to understand and advice about the solvency status of the company (Bosker, 2017).
Being an accountant of TIBE, the duty was bestowed upon me to research and give a report to my supervisor about the assessment of the status of solvency of DDW as per the legislative provision of law vide section 95A of Corporation Act 2001. After critically analyze the case of DDW Pty Ltd, I have to identify also if some other relevant information is also required from DDW Ltd to make the report well organized, and to the point with probable suggestions about the future course of action by the company in consideration of the solvency of the company.
This report is to be provided in the form of memorandum of advice which will cover three situations;
- Insolvency detection of DDW Pty Ltd
- Suggestion about the provision of external administration and turnaround process for DDW Pty Ltd
- Required information from DDW to make the report authentic and meaningful
I will furnish them below with the provision of legislation as provided by the Corporation Act 2001 of Australia. The report will be given in the form of Memorandum of Advise (Topp & James, 2015).
Memorandum of Advice
To – The Supervisor
Subject- DDW Pty Ltd- Insolvency, probable external administration process and turnaround steps, and need of further records from DDW for effective report construction
Detection of Insolvency for DDW Pty Ltd- ILAC Method
The main issue is to find the possibility of insolvency detection of DDW Pty Ltd as the company is unable to repay its debts in due time because of its shortage of liquid fund.
The Corporation Act, 2001(Cth) of Australia has specified the insolvency of any entity though its regulation vide Section 95A (2). This entity will cover any person or corporate body. Main enquiries are to be done under the said section 95A (2) is to detect the solvency criteria of any company with the consideration of below conditions:
- Is the corporate body be able to repay its debt to the creditors in time as per the terms and conditions specified which is determined by the factors like liquidity position of the corporate which is mainly determined by the availability of cash reserves, positive working capital, healthy cash flow situation, accessibility of reliable alternative sources of funding for the corporate, monetary strength of the corporate for borrowing from the market, value of realizable assets to repay debts with the consideration of time and date frame(Svpartners, 2015).
As per the judgment of Justice Emmett in the case of Quick vs. Stoland of 1998 with no. 157 ALP615 at 622, there are four factors which were set out for consideration. They are:
- Quantum of the debt of any corporate body is to be ascertained as per the date and time of repayment which was agreed during taking the debt in written or verbal form as per the terms and conditions of payable debts with time of fallen due.
- Evaluation of all assets of the company as per the date and time in question of repaying debts with their liquidity and realizable value.
- Anticipated quantum of cash flow of the business is to be find out with the anticipation of cash in-flow from projected sales and respective payouts in the form expenses to be deducted from them(Austlii, 2015).
- Understanding between the lenders and creditors of the company and the management of the company to distinguish the shortfall of liquidity of the company in the way of proper information of realizable assets with value and cash flow for assuring coverage of future loans to be repaid alter comparing to the present borrowing.
This same case has been enriched with the statement of Justice Finkelstein which said that identification of justified clauses for not paying debts by the company by due time should be taken into consideration as justified due to the merit of the case. This situation should to be considered by the aspect of commercial reality which attracts the requirement of considering the financial condition of the company with the wholesome effect, which should be included of its activities, availability of fund to pay liabilities by the action of sale of realizable assets, or through flow of cash, asking for fresh debts from the market with the inherent strength of the company to attract capital raising from the market. Refer to definition of section 95A, it is also suggested that the viable test of proving solvency by any company is the cash flow test which seems to be more realistic than the exercise of balancing assets with liabilities (Austlii, 2001).
The act of section 95A has the provision with two rebuttable presumptions of insolvency which are depicted in the Act vide section 588 E. these presumption are in related to proceedings of recovery as per the applicability of civil case and criminal case. These presumptions are mainly justified with the facts which are subject to rebutting with the application in case of directors involved in the financial operation of the company and assigned to manage the financial activities. The term insolvency, as contained in section 95A is clarified in statutory way should only being relied upon when the application of statutory presumptions of insolvency as per applicability of subsection 588E (3) and 588E (4) with the provision of not subject to rebuttal of presumptions (Debtrecoveryqld, 2016).
Presumption one is related to proof of continued insolvency which is valid at a certain date as per sub section 588E (3). This provision is clearly mentioned that the company subject to closure is proved to be insolvent for any particular period during the period of 12 months before to the relation-back day which is generally taken as the date of application of closure of the company as filed or with the appointment of the administrator, this presumption is taken as the criterion for the company to be declared insolvent since that period up to the relation-back day (Austlii, 2015).
Presumption two is depicting the criteria of insolvency for the said situation which is depending upon the situation of non-providing of sufficient and logical accounting records as per justified financial transaction as per section 588E (4).this presumption is subject to proof of non provision of accounting and financial records by the company either for their inability or providing them or for their inability to correctly explain them to justify their financial position. There is another option that if the company is unable to keep accounting records for last seven years after the period when the related transactions had been there, it is to be presumed that the company was fallen in the stage of insolvency during that period. This presumption has not been applicable in case the company had failed to maintain the records of accounts in technical or minor stage, with the non-applicability in case of removing accounts by destructing or concealing those by any other person who is not identified as the defendant direction as per the situation which has no proof that the defendant direct had no involvement in those actions.
Indication of insolvency-Australian Securities and Investment Commission or ASIC had given list different major financial and operational activities which can be determinant to indicate insolvency for any company. They are:
- Absence of cash flow projection
- Unorganized way to maintain accounting of the company
- Unavailability of complete records of financial information
- No presence of budgets and plans by the corporate for different wings of operation
- Continuation of such activities which can generate losses
- Accumulated impact of higher liabilities that assets
- Inability of the company to pay dues in the form of debts or interest by due time
- Gradual increase of involvement of financiers
- The age-wise analysis of creditors goes beyond 9- days
- Ad-hoc system to pay debts with the happening of judgment of debts
- Government payment non-compliance like tax or employees’ superannuation
- Facing difficulties to get finance from external sources
- Realization of current assets is getting tough
- Loss of personnel of key management capacity(Asic, 2016).
The above conditions prevail in case of DDW Pty Ltd as the company is passing the crisis of cash shortage with other financial operations of the company are proving to be vulnerable for the company to carry on business. The applications of above conditions for the company are highlighted below:
- The basic parameter of financial strength of any company is to be found from working capital and cash flow analysis.
- Refer to the financial information provided by the company, the working capital analysis had shown alarming signals of negative working capital with current liabilities are more than current assets.
- Although the current assets were considered at book value, the realistic value showed lesser asset of inventory by 20% due to damaged stock which is not saleable in nature.
- The receivables of the company are with the terms of 180 days which is not ideal as the company is running the practice of paying debts with 90 days limit. This situation automatically creates cash crunch as the inflow of money takes longer period as the outflow of money takes shorter period and that’s the reason why the company is running out of cash or with bad liquidity proven by the activity of the company.
- Operations of the company had found higher level of overhead costs on rent of warehouses, salary of staffs and gradual changing of business situation with increased competition from online vendors reducing revenue at steady pace. This is responsible for gradual shrinkage of profit margin.
- The company is unable to maintain proper records of accounts due to high turnover of human resources and this led to incomplete financial record and accounting reports(Omar, 2016).
With the above discussion following ILAC Method, the last part is given below as conclusion:
- The creditors of DDW were not paid off their debts in due time and some of them had proceeded to the court for recovery of their money.
- The accounting system of the company is casual and not strict without reconciliation with third parties, causing confusion at the end of creditors about their real recoverable amount as the company record and their record differs.
- Management of working capital is really bad and due to the unprofessional stickiness to the older practice of receivable and payable management, there is no sign for early recovery from this situation.
- Proper cash flow statement is not provided by the company, but with the available records it is evident that the company cannot manage working capital in effective way which is prevalent with their traditional strategies of creditors’ payment limit of 90 days and debtors’ payment time with 180 days. This situation obviously creates cash shortage.
- There is the incident of sponsoring gift by the company for the kin of the directors which has also direct impact on the cash management of the company.
External administration process and turnaround steps- ILAC Method
The issue of this case is to provide options for the management of DDW Pty Ltd to ask for external administration or turnaround process as per guideline of ASIC or Australian Securities and Investment Commission. The guideline of ASIC provided in this situation restricts the company to go for further debt if they are gradually tending towards insolvency. The standard process is to appoint voluntary administrator or liquidator.
Respective law is Section 95A of the Corporation Act, 2001 of Australia.
Voluntary administration-This provision is extended to give direction to the affected companies for future course of action. Voluntary administration is performed by a person who is aptly qualified and independent in nature and has the ability to take total control of the specific company to guide them with best possible solution to ensure safety and security to the company and the external stakeholders. This objective can be met through a deed of company arrangement. This is proved to be the fastest option as the appointed voluntary administrator by the board of directors can have the ability to resolve the issues. This process needs to be consented in written form from a registered liquidator who can play the role of voluntary administrator (Asic, 2013).
Liquidation- Basic objective of this activity is to ensure that under the control of any independent and qualified person, the company would wound up in the process which ensures prudence and fairness for all the external stakeholders of the company.
Receivership-This is made by secured creditors to appoint receiver to control all or few of the realizable assets in order to ensure repayment of debts.
Refer to the process voluntary administration; the company has to opt for this for resolving the monetary situation of the company by providing scope of directors to manage the situation with the guidance of professionally qualified person.
Requirement of further records from DDW for effective construction of report
Considering the case of assessing insolvency of DDW, further requirement of documents are there in the form of audited accounts report with the comments of the directors and the auditors so far compliance of accounting procedure as per AASB standard is concerned. This requirement could be met with specific reports in the status of consolidated financial statements, comprehensive income statement, cash flow and analysis of owners’ equity. These reports are required for last five years in order to conclude and prepare a constructive report of the company DDW. These reports will enable me to furnish a report which will be analytical, comprehensive and informative in nature. The final report will obviously give direction to the company through which the company can come out of this dilemma. The demand of the situation also generates the necessity of creditors’ and debtors’ accounts with confirmation from them in order to avoid unnecessary ambiguity. It also advised to consider the value of inventory in realistic manner by destroying the damaged inventory for arriving at the proper position of the company.
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