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Leadership 101 – The Role and Responsibility of Directors – Part 8

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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 budges would be included her 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.”

• 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.)”

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 taking 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.