Presented by Jones Partners
Throughout 2023, cases of corporate insolvency returned to (and even exceeded) pre-COVID levels. It has been a challenging year, with economic conditions creating a hostile climate for businesses. High interest rates, war in Ukraine, COVID stimulus, and labour shortages have all contributed to the current climate. These conditions have driven numerous high-profile businesses into insolvency, including Porter Davis Home Group, Sarah Lee and Scott’s Refrigerated Logistics. Despite the unique challenges facing each of these companies, there were several main causes of insolvency for 2023.
Supply Chain Issues
Supply chain issues are a continued legacy of the pandemic, perpetuated by other global disruptions, such as the Russian War in Ukraine. The war continues to cause significant disruptions to trade routes, resulting in delays, increased uncertainty and reduced supply. Global suppliers raise prices in response to these disruptions and uncertainties. Ukraine has a large agricultural export, as well as sizeable steel and energy industries. It also has significant natural gas reserves. A pause in Ukrainian production increases the pricing power of other global producers.
Declining sales occur due to a number of factors, but economic downturn is usually the greatest contributor. Rising interest rates and persistent inflation force consumers to pull back on discretionary spending. Inflationary pressures also compel companies to raise prices, further contributing to declining sales.
Absence of Working Capital
‘Cash flow’ or ‘working capital’ is often referred to as the ‘life blood’ of any business. It is essential for meeting basic operational expenses, such as salaries, utilities and supplier payments. Working capital is also crucial for effective risk management, by creating a healthy buffer for economic downturn or other unexpected events that may affect revenue. The nature of business is unpredictable, and fluctuating demand is sometimes unavoidable. Access to plenty of working capital will have a stabilising effect during uncertain times.
Labour shortages lead to rising labour costs. Australia is currently experiencing a significant skills shortage across several industries, with construction being the most adversely affected. A limited supply of labour increases worker bargaining power, as businesses are forced to compete for a limited pool of talent. Businesses must offer higher wages to retain workers, which increases expense and undermines profitability.
Fixed Price Contracts
Fixed Price contracts are perhaps the greatest, underlying contributor to the increase in construction industry insolvency. ‘Fixed price’ refers to contracts where the price for a service is determined at the outset and will not change (regardless of any fluctuation in the contractor’s costs). Whilst this contractual model does ensure predictability for buyers, a significant increase in labour and material costs will render these fixed price contracts unprofitable.
Poor management is the final (and most detrimental) contributor to a struggling business. Poor management has a cascading effect on all aspects of a business, including operations, financial health and interpersonal relationships. Records of corporate insolvencies by ASIC for the 2021-2022 FY show that 39.8% of business failure was caused by poor strategic management.
Most incidents of insolvency are recoverable, provided individuals seek out expert advice, early on. Pragmatic leadership is key to navigating uncertainty and implementing effective turnaround.
Keen to read more? Check out our blog on Zombie Businesses