Budget Surplus Masks Economic Uncertainty: Insolvency Trend Signals Challenges Ahead

Budget Surplus Masks Economic Uncertainty: Insolvency Trend Signals Challenges Ahead

Building on last year's surplus momentum, this year's budget follows a similar path, with some key adjustments to address ongoing inflationary pressures. The Reserve Bank of Australia's continued rate adjustments represent a proactive stance for the government in tackling inflation. However, the increasing trend in insolvencies highlights businesses' underlying economic challenges, revealing that the projected short-term budget surplus may not indicate sustained economic growth and stability.

Looking ahead, fiscal projections present a more complex picture. Forecasts indicate substantial deficits of $28.3 billion in 2025 and $42.8 billion in 2026, primarily driven by government-led cost-of-living relief measures and the need to address health funding and frontline services spending. These measures, while necessary, could potentially exacerbate inflationary pressures, underscoring the delicate balance the government must maintain to steer the economy toward stability.

With inflation projected to gradually decrease to around 4%over the next year, the government's commitment to achieving its inflation targets of over 2% by 2025 is unwavering. This commitment underscores the government's careful balancing act between fiscal responsibility and the imperative of sustaining economic growth and stability, a task that is not without its challenges.

The fiscal equation is further complicated by global economic uncertainties and tightening measures from the Australian Taxation Office (ATO), which pose significant challenges for some businesses. As these businesses navigate uncertain market conditions and increasing debt obligations, the ATO's intensified debt recovery efforts post-pandemic add another layer of complexity to the situation. This highlights the need for businesses to engage in careful financial planning and risk management.

Federal budget unveils modest measures for small businesses and individuals

Under the Energy Relief Bill, small businesses are eligible for relief grants of up to $325, while individuals will receive $300 to help alleviate personal financial burdens. Continuing its commitment to support businesses, the government has extended asset write-offs for another year, providing opportunities for investment and growth. Small businesses with turnovers below $10 million will benefit from the instant asset write-off, now set at $20,000, extended for another year to stimulate growth.

The government has implemented stage 3 tax cuts for individuals, with Australian taxpayers set to benefit from an average annual saving of $1,888. These cuts are part of a restructured income tax system envisioned by the Labor government. Additionally, from 1 July 2023, retrospective changes to HELP debt indexation to the lower CPI or WPI aim to ease the financial burden on graduates, who stand to gain an average of $1,200 from these adjustments, though the full benefits may not be realised for many years and the principal debt covered by the government will not be materially reduced.

In support of families and financial security, the government will introduce government-funded superannuation contributions during government-funded paid parental leave starting from 1 July 2025, with an allocation of $1.1 billion over four years. This initiative aims to mitigate the impact of parental leave on retirement, though the benefits are likely to be realised around 30 years from now, barring any hardship applications.

Furthermore, a review of the Australian Taxation Office's role in superannuation enforcement is underway. The recalibration of the Fair Entitlements Guarantee Recovery Program aims to enhance efforts to pursue unpaid superannuation owed by employers in cases of liquidation or bankruptcy from 1 July 2024. These measures may significantly impact the insolvency industry, with relevant stakeholders expected to provide guidance on navigating these changes, particularly in practical implementation.

Budget paves green path- investing in Australia's future sustainability

The budget highlights the government's commitment to the "Future Made in Australia" initiative, allocating $22.7 billion over the next decade to capitalise on the economic and industrial advantages of transitioning to net zero emissions. This strategic move aims to secure Australia's position in a rapidly evolving global and economic environment.

In line with this vision, the government has introduced a range of measures to encourage private sector investments, particularly in green industries. Businesses operating within the green sector emerge as clear beneficiaries in the budget, with substantial investment expected to drive innovation and growth over the next decade. The timeliness and efficiencies in the supply chain and resource allocation will be crucial as this progresses to create sustainable industries. This strategic allocation of resources positions Australia to emerge as a renewable energy powerhouse, fostering sustainability and resilience in the face of global challenges.

Challenging market conditions continue to linger

As with the 2023 budget, the 2024 budget has been introduced in a challenging economic environment. As of May 2024, the Reserve Bank of Australia (RBA) has set the cash rate at 4.35%, marking it the highest in over 13 years. This increase is part of a broader strategy to contain inflation, aiming to maintain it within the 2-3% target range.

Inflation - impact on individuals and businesses

Inflation appears to be stabilising, thanks partly to several budget incentives designed to keep it under control. Despite these measures, the effects of past monetary injections during the COVID-19 pandemic are still being felt. These injections, intended to support consumers during the economic downturn caused by the pandemic, have led to persistent inflationary pressures. However, unlike inflation driven by robust economic growth, this inflation stems from the increased money supply rather than a booming economy.

Increasing living costs are another significant factor contributing to the current market challenges. High inflation, elevated rates, and the ATO debt recovery activity have added additional financial pressure on individuals and businesses struggling to adapt to the post-pandemic economic landscape.

Voluntary administrations on the rise

The steady rise in voluntary administrations among businesses may be correlated to the proactive measures taken by companies to avoid severe consequences such as Director Penalty Notices (DPNs) and winding up applications. Between 1 July 2023 and March 2024, the ATO issued 18,343 DPNs that relate to 13,454 company liabilities totaling more than $2.5 billion and has filed a total of 724 wind-up applications in the Federal Court. Faced with mounting financial pressures and the risk of personal liability, directors are increasingly opting for voluntary administration as a strategic move to manage their company’s debts and restructure their operations.

The number of insolvencies can continue to increase due to the “domino effect” of customers' inability to repay debts. We expect this upward trend in appointments may continue.

The figures provided for 2023-2024 do not encompass data for the entire year. However, based on ongoing activity, we anticipate that the current levels will surpass the figures reported below.

Source: Australian Securities and Investments Commission (ASIC): Insolvency Statistics (current)

Budget surplus - how does it impact businesses?

While a budget surplus has been projected, it is seen as a temporary measure within in an election year and does not seem to address the underlying economic challenges. The surplus is unlikely to provide significant relief to businesses facing ongoing financial difficulties, as substantial deficits are forecasted for the future. This short-term fiscal strategy fails to mitigate the long-term pressures that businesses and the economy will face.

Cash flow challenges

High interest rates and mortgages

The sustained high interest rates, with the potential for further increases, continue to strain the cashflow of businesses and individuals, particularly those with mortgage liabilities. The incremental relief anticipated in the future is expected to be minor and gradual, providing limited respite over an extended period.

Business owners with property mortgages face increased repayment costs, reducing available capital for business operations and growth.

Superannuation payment changes

Starting 1 July 2026, businesses must pay superannuation contributions concurrently with salary and wages, ensuring they are not deferring payment obligations. This change imposes additional cash flow pressures on businesses, as they must ensure sufficient funds are available to meet these obligations in real-time rather than deferring payments for three months.

Personal insolvencies linked to corporate debts

The trend of rising personal insolvencies is also expected to continue, according to AFSA. Volumes are expected to rise by 23% in 2023-24 to around 1250 and by a further 20% in 2024-25 to around 14,750. Many individuals who have provided personal guarantees for corporate debts are liable when these corporations become liquidated. The inability of these companies to meet their financial obligations often forces guarantors into personal bankruptcy, further straining the overall economic environment.

Australian business confidence

Business confidence serves as a crucial indicator of overall economic health and sentiment. When business confidence is high, it often correlates with increased investment, hiring, and economic expansion. Conversely, low business confidence can signal caution, reducing investment, hiring, and slower economic growth.

The NAB Business Confidence Index remaining at 1 in April 2024 for the second consecutive month, and at least neutral for five consecutive months, suggests a level of sentiment stability, albeit below its long-run average. This stability may reflect a cautious outlook among businesses, possibly influenced by various economic factors.

For instance, while sectors such as recreation and personal services, construction, and manufacturing show improvements, weak sentiment persists in retail, wholesale, and mining. This mixed sentiment could be attributed to broader economic conditions such as slower GDP growth, fluctuations in consumer spending, or uncertainties surrounding global trade dynamics.

Moreover, the decline in business conditions, driven by reductions in sales and employment despite steady profitability, underscores the challenges businesses face in navigating the current economic landscape. Factors like rising inflation, interest rates, or concerns about geopolitical tensions may contribute to this cautious sentiment among businesses.

Source: | National Australia Bank

Industry perspective - Construction

Construction remains the dominant sector for insolvency appointments, representing 27% of total insolvencies in FY24 year-to-date. Compared to 2021 to 2022, insolvencies in this industry have almost doubled.

Source: Australian Securities and Investments Commission (ASIC): Insolvency Statistics (current)

In response, the government has implemented measures aimed at revitalising the construction sector:

  • Housing sector boost: A $4.3 billion injection into the housing sector to benefit developers, tradies, and social housing providers, aiming to counter record-high company failures.
  • Visa fast-tracking: The government has fast-tracked visas for 1900 migrants to alleviate labour shortages in housing construction.

However, it remains uncertain whether these initiatives will effectively address the underlying causes of insolvencies within the industry. Major contributing factors include:

  • Fixed-price contracts: Many construction companies entered into fixed-price contracts without anticipating subsequent supply cost increases, eroding profit margin
  • Supply shortages and delays: Ongoing supply chain disruptions and severe labour shortages have driven up prices and caused significant delays in project completion.
  • Market conditions: The tightening of trade debtor insurance and credit terms by suppliers has compounded financial difficulties, particularly for volume builders. Consumers being unable to obtain finance has led to reduced fulfillment in scheduled     start dates.
  • Regulatory changes: New regulations have slowed government approvals and permits.

These challenges have predominantly impacted volume builders in recent times like Porter Davis, St Hilliers, CMG Homes, ProBuild, and Mahercorp Group.

Cor Cordis’ construction appointments
Cor Cordis’ successful restructuring of prominent Victorian homebuilders Mahercorp Group, S & K Group, Harmac Homes, and, most recently, Langdon Building showcases the importance of effective management, strategic decision-making, and collaboration with key stakeholders. Our restructuring efforts have enabled projects to be completed and revitalised, positioning these businesses for future growth.

Industry perspective - Accommodation and Food Services

While the construction sector has received government support, the food and accommodation industry, the second most affected by insolvencies representing 15% of total insolvencies in FY24 year-to-date, has seen less targeted assistance.

This industry, significantly impacted by COVID-19 and associated lockdowns, continues to struggle with several persistent issues:

  • Debt accumulation during COVID-19: Debts that accrued and not enforced during the pandemic, including those owed to the ATO and landlords, remain a significant burden on businesses in this sector.
  • Cost of living and mortgage rates: Rising living costs and increasing mortgage rates will likely constrain discretionary spending, directly affecting the food and accommodation industry’s revenue streams.

Despite the budget’s focus on the construction sector, it appears there are no new or increased incentives for the food and accommodation industry. The lack of targeted financial support exacerbates the sector's ongoing struggles, such as historical debt load. Businesses are still grappling with debts accumulated during COVID-19, which were not enforceable then but have since become due.

Cor Cordis’ food services and accommodation appointments
The financial distress in the food and accommodation sector has led to many insolvencies. Most of our recent appointments in this space have resulted in shutdown scenarios due to negligible asset values. We have successfully restructured or overseen an orderly winding down of businesses in this space, with the aid of contributions, deals with landlords, and external funding, particularly for the successful restructures. We anticipate that the food and accommodation industry will continue to experience many insolvency appointments. This expectation is bolstered by the increased activity from the ATO, which is likely to press for debt recoveries, adding further pressure on financially vulnerable businesses.

Closing thoughts: adapting to fiscal realities and embracing uncertainty

Unfortunately, the projected short-term budget surplus does not indicate sustained economic growth and stability. Instead, we are facing challenging times ahead, as evidenced by a continued trend in insolvencies. If the forecasted budget deficits for 2025 and 2026 materialise, additional spending must target the root causes of financial difficulties. Neglecting these issues may perpetuate financial instability, leading to significant budget deficits.

We are witnessing insolvencies returning to levels like those seen before the COVID-19 pandemic, albeit in a higher inflationary environment—a trend not observed in previous years. The trajectory of the budget and any additional inflationary pressures will be pivotal for both the business community and individuals grappling with the cost-of-living crisis.

Amidst these uncertainties, early engagement and professional advice remain vital for businesses navigating the evolving economic landscape. Proactive measures are essential to instill confidence and resilience within the business community, as depicted in the current level of business confidence.

In conclusion, strategic planning, prudent financial and cashflow management, and a proactive approach to addressing challenges are crucial for businesses to thrive in the face of economic uncertainty. These proactive measures are also fundamental for facilitating successful restructures.


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