Business insolvencies up 19.6% since height of GFC

Australian SMEs are succumbing to increased pressure in the current economic climate, according to Veda, Australasia's leading provider of business intelligence services and solutions. Veda analysis of Company Default and Insolvency data for the April to June quarter 2011 reveals the number of companies entering external administration increased 6.3% on the June 2010 quarter and up 19.6% on the June quarter 2008, during the height of the first GFC.

Companies with 10 to 99 employees were significantly over represented against the broader population in terms of going into external administration in the 2011 financial year, accounting for 23.3% of all administrations. Businesses between their 2ndand 4th year of operation were also proportionally higher, at 29%.

Moses Samaha, Head of Commercial Risk at Veda said: "Concern over a possible global credit crisis, reduced consumer sentiment and delays in customer payments are no doubt adding strain to business cash flow. Tighter financial and credit management practices will now prove vital for SMEs to avoid the risk of insolvency over the coming 12 months.

"Assessing the credit risk of a potential creditor should be a number one priority for any business looking at taking on new customers and suppliers. This is necessary to help minimise business exposure to bad debtors and to help safeguard against risky business relationships. Organisations should also undertake a thorough background check on company owners and directors and not just the business entity itself."

Of the businesses entering external administration, the construction industry accounted for the largest proportion, at 19.8%. This was followed by manufacturing (13.9%), retail trade (8.8%) and professional, scientific and technical services (8.3%).These sectors also make up the largest proportion of defaults. Mining, information and media, and education and training accounted for the least amount of external administrations at 0.7%.

The construction industry is also the sector most actively seeking new credit in the April-June quarter, at 20.4% of all applications. Manufacturing and retail trade followed closely, contributing 15.3% and 9.5% respectively.

Comparing external administrations and defaults to credit demand also highlights a possible weakness in the accommodation and food services sector. The sector accounted for 10% of all business defaults and 7.1% of external administrations, but represents only 4.6% of credit enquiries (June quarter 2011). "This is potentially a sign of poor credit management practises in these sectors", said Mr Samaha.

Mr Samaha said Veda's range of trading history and commercial credit reports were one of the best ways to help businesses defend against involvement with risky customers."Ignoring the signs of a problem customer or supplier could be the difference between collapse and survival."

Before offering credit or signing a new customer, Veda recommends businesses adopt the 5C's of credit - character, capacity, capital, cashflow and conditions - and use as a guide in assessing the credit risk of potential creditors.

1. Character: Research the people behind the organisation you are dealing with. It's important to assess a person's willingness to pay, based on their overall attitude, their company values and the financial track record of the business and its leaders. Check for any signs of a dark financial past. Factors such as past defaults or court actions can give important insight into the financial and ethical standards behind the people running the business.

2. Capacity: Assessing the prospective organisation's capacity to generate sufficient cash flow to cover any outstanding debts should be the highest priority of any credit manager. This is critical before investing in a company or extending a large amount of credit.

3. Capital: Understand your customer's capital base, including their cash and other assets, as well as shareholder commitments. This is important to ensure credit has not been extended to an organisation that can't afford to repay their debt.

4. Cash Flow: Cash flow is the "lifeblood" of any business. Poor creditcontrol will greatly affect cash flow and the ability to pay debts on time, so it pays to develop an understanding of the financial situation of the business to which you are extending credit. This will give you an indication of how swiftly they may pay you for your products or services and the likely impact on your company finances.

5. Conditions: The current economic conditions in each marketplace may affect the ability of a business to repay debton time, which may require adjustment of your credit policies. Consider factors such as the impact of international economic conditions on the domestic market, such as offshore financial volatility and fluctuating exchange rates, as well any changes in the political landscape. Is the prospective customer susceptible to economic downturns?

Veda analysis of external administrations (EXADs) by sector and state (June quarter 2011)

• Across all states, the June Quarter 2011 was up 6.3% on the June 2010 quarter, mainly due to large year-on-year increases in EXADs in NSW and VIC. The month of June also recorded the second highest volume of external administrations since March 2009.

• SA recorded the highest year-on-year growth in external administrationsat 27.3%. NSW recorded the second largest result (8.5%), followed by WA (4.8%). QLD was the only state to record a decline at -8.7%.

• The construction industry accounted for the highest proportion of external administrationsin all major states(QLD, 24%, WA, 23%, VIC, 20%, NSW, 19%, SA, 15%).

Veda analysis of ASIC insolvency appointment data - State results (June quarter 2011)

• Total insolvency appointments in the June quarter 2011 were down 1.3% on the June quarter 2010, driven by large year-on-year falls in insolvency appointments in QLD.

• SA (15.6%) and NSW (5.4%) recorded the largest year-on-year increases in insolvency appointment volumes in June 2011.This was followed by WA (4.9%) and VIC (1.8%).

• QLD recorded a year-on-year decline in insolvency appointments, at-20.8%.