Please note that this pertains to South African Legislation, the King Requirements, and Best Practice.
Today we are having a look at the requirements around the Solvency and Liquidity Tests.
The sad truth and reality that I find in most of the SMME clients that I assist, is that they have no idea whether or not they will be solvent next month, never mind for the next 12 months and I know for a fact, that many never even knew about this requirement, much less how to conduct it.
The fact of the matter is that these tests should be done on a regular basis to ensure that the company is, in fact, liquid and therefore in compliance with the New Company’s Act. Remember failure to meet the requirements of the New Company’s Act essentially means that you, as the Director or the Business Owner can be held liable in your personal capacity.
Issues that need to be tested are (but not limited to):-
– The Net-worth of the Company must be calculated and the assets (no inflated prices please, but rather a fair trade value), must be greater than the liabilities. Obviously, these should also include ”all reasonable foreseeable” (so your forecasts and budgets would be included here too), contingent assets and liabilities.
Make sure that your figures are current as you will only have yourself to blame if your calculations are off.
– The Company must also be able to pay its debts as and when they fall due for at least 12 months. These debts, of course, are the ones that are incurred in the normal day-to-day running of the business.
Here’s the kicker! The following instances are when a Director can be held personally liable for loss, damage, or costs sustained by the Company as a ‘direct or indirect’ consequence of their actions:-
• When the Director is “present at the meeting where the resolution was considered or participated in the decision.”
So this means, that when, at a Board Meeting that was held, it was decided that the new ‘super-duper. super fast, super everything, company jet would be purchased at a cost of R2m. The decision was made despite the fact that the books and forecasts indicated that there would not be sufficient funds to meet the running costs of said machine and although there were several Directors that opposed the purchase, this was not in the minutes, but what was in the minutes was that they were present at the meeting.
• Where the Director “failed to vote against the resolution, despite knowing that it was inconsistent with the requirements of the Act or the Company’s memorandum of incorporation or the Director did not responsibly consider its impact (this would include the instance where the Company undertook any of the above transactions when it was not in a position of solvency and/or liquidity.)”
Let’s take the above example of the purchase of a company jet. In this scenario, the purchase was put to the vote, but despite the fact that the Financial Director knew that there would be insufficient funds to meet any running costs of the jet, he did not oppose the purchase of the asset. In this case, the minutes showed that there was no-one opposing the purchase of the jet. In this case, the FD would have “Failed to vote against the resolution, despite knowing that it was inconsistent with the requirements of the Act or the Company’s memorandum of incorporation or the Director did not responsibly consider its impact (this would include the instance where the Company undertook any of the above transactions when it was not in a position of solvency and/or liquidity.)”
So the guys who get funding from the bank to purchase machinery that will reduce the costs of producing their product by 75% and they take that money and go and buy the latest Lamborghini – this applies to you. You are not compliant with the Act and can be held responsible in your personal capacity, despite the fact that the Lamborghini is registered as a ‘Company Vehicle!”
So what are the questions that Directors should be asking to ensure that they do not put themselves or their reputations on the line?
1. Firstly, does the transaction that is being voted on require a liquidity and solvency test? Understand that these are not for the daily run of the mill type transactions. These are the types of transactions where, for example, the Board is making a decision to purchase their own building or buy land in order to build their own premises, or buy a fleet of trucks to deliver the merchandise instead of outsourcing that function, type transactions.
2. Secondly, before the Directors can make an informed decision about point 1. above, they will need to have the necessary (and sufficient) information to allow them to determine whether the Company will still be solvent after the transaction has taken place.
3. The Directors also have to ensure that all the assets and liabilities of the Company have been fairly valued (not over-stated and certainly not just the “book” value that is recorded on the Asset Register.)
4. Finally the Directors have to ensure that the calculations also take into account all the contingent assets and liabilities.
Clearly, this is not a quick “tick-box” type exercise and the information that the Directors need to both see and analyze must be accurate. This is to ensure that they are able to reach an informed decision and that that decision is one that makes good business sense and that they will also be able to keep the Company healthy from both a growth and a sustainability perspective.
Next time we will have a look at specifically what those financial controls are and what is required.