Is this over trading or some form of fraud?

54and56

I'd like to know if the following situation is either Over Trading, Fraud or just poor practise which may lead to bankruptcy and customers losing out but nothing more severe than that in terms of breaking any laws.

Company A is a business which takes 12 month subscriptions from customers up front (such as a gym for example where customers renew fairly evenly throughout the year but there's a peak in January) and after a number of years the business finds itself with say €500,000 in customer prepayments recorded as current liabilities on it's Balance Sheet (as it owes up to 11 months service to it's customers at any one time) but it has no cash (so hasn't been keeping cash from customer prepayments separate in any way), it has no Debtors and has no other assets with any sort of disposal value so insolvent to the tune of €400,000.

I recently had cause to look up a company on CRO which had similar characteristics to the above with a negative balance sheet posted for the last reported year and 8 months on it's still trading and still has an excess of liabilities over assets with no sign of improvement.

The business basically relies on the next months 12 month renewals in order to meet payroll and other costs for that month i.e. it's going to use all the funds from customers making 12 month subscription renewals in March to make payroll and other operating costs in March.

Is there an actual name for this sort of sailing close to the wind and is there any way it is supposed to be identified and put right early if the business owner is blind to the problem?

DubCount

The issue here is the consideration of going concern. There should be reference to the going concern basis in the notes, and if the auditors had concerns, there may be some kind of qualification or emphasis of matter. Its not impossible or unreasonable to have an expectation of sufficient renewals to ensure the company will survive for at least 12 months.

54and56

Thanks DubCount, I checked the notes on the accounts ref the Going Concern status and the Directors in their Responsibilities Statement confirm that the financial statements were prepared on the basis that the business will continue as a going concern.

Because this is a relatively small business it is exempt from the statutory audit requirement so the external accountants who compile the financial statements clearly state they have not audited or in any way verified the financial data provided to them by the company and they make no statement nor express any opinion whatsoever in relation to them.

Ref the negative Balance Sheet. I thought if a company's liabilities exceeded their assets the directors would be obliged to inform creditors or take some action to prevent new suppliers or customers from advancing credit to a company that is insolvent or that once the insolvent status was confirmed/acknowledged the company would be obliged to cease trading or take some remedial action if it wanted to keep trading such as a fresh capital injection?

I just looked at the accounts there and I can see that the Balance Sheet was also negative the preceding year by a lower but still significant amount. Can a company really continue to trade for several years in an insolvent state?

ACADasltiv

Insolvent means not being able to pay bills as they fall due. They may be balance sheet insolvent yet be able to meet their payments as they fall due. If the deficit has gotten bigger then they're obviously trading at a loss and it can't go on indefinitely, however they could be restructuring and instigating cost cutting measures to try and reduce the deficit and bring it back to profitability.

Having a surplus on the balance sheet doesn't necessarily mean it's a solvent company either. I've seen companies with €1.5m plus in shareholders funds on its last set accounts show a deficit of €2m+ on the statement of affairs at creditors meetings when it goes into liquidation.

Je_suis_Jean wrote: »

Company A is a business which takes 12 month subscriptions from customers up front (such as a gym for example where customers renew fairly evenly throughout the year but there's a peak in January) and after a number of years the business finds itself with say €500,000 in customer prepayments recorded as current liabilities on it's Balance Sheet (as it owes up to 11 months service to it's customers at any one time) but it has no cash (so hasn't been keeping cash from customer prepayments separate in any way), it has no Debtors and has no other assets with any sort of disposal value so insolvent to the tune of €400,000.

There's no obligation for the Company to keep the cash in a separate account and it also wouldn't be practical. Insurance may be paid in a lump sum - there's probably 100 members fees gone towards that it one payment, rent has to be paid etc. In construction companies the main contractors generally don't hold retentions due to their subcontractors in separate trust accounts, and that is actually the subcontractors money which they receive after a set amount of time has elapsed with no snags.

54and56

ACADasltiv wrote: »

Insolvent means not being able to pay bills as they fall due. They may be balance sheet insolvent yet be able to meet their payments as they fall due.

That's very true and not the way I was looking at it at all.

Looking at their Balance Sheet I can see their current liabilities are 3X their current assets but as the majority of current liabilities are customer prepayments and they seem to have steady renewals I guess you could argue providing renewals continue to roll in each month they can be confident of meeting their bills as they fall due. I'm not sure I could sleep at night running a business where working capital was that tight but I guess if they've been doing it for years it's just become the norm for them!!

ACADasltiv wrote: »

Having a surplus on the balance sheet doesn't necessarily mean it's a solvent company either. I've seen companies with €1.5m plus in shareholders funds on its last set accounts show a deficit of €2m+ on the statement of affairs at creditors meetings when it goes into liquidation.

Very true, having a lot of illiquid assets (such as specialist used equipment or even acquired goodwill) will not help you pay the bills that's for sure.

ACADasltiv wrote: »

There's no obligation for the Company to keep the cash in a separate account and it also wouldn't be practical. Insurance may be paid in a lump sum - there's probably 100 members fees gone towards that it one payment, rent has to be paid etc. In construction companies the main contractors generally don't hold retentions due to their subcontractors in separate trust accounts, and that is actually the subcontractors money which they receive after a set amount of time has elapsed with no snags.

Good to know.