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Insolvencies up (and back to normal levels)

Australian businesses are facing significant challenges in 2022, dealing with high inflation, rising interest rates, acute skill shortages and a slowing global economy. And these factors are starting to take some toll, with the number of Australian companies going into external administration increasing by 23% over the year to June quarter 2022 (Chart 1).

The average number of insolvencies being seen is actually considerably lower than pre-pandemic levels. The moratorium on insolvent trading (which suspended a director’s duty to prevent insolvent trading) coupled with considerable government support through various pandemic payments have in effect kept some ‘zombie firms’ alive over the past few years. Rising insolvencies in 2022 suggest some of these companies have now failed, but also highlight the challenges of the current financial environment.

Chart 1: Insolvencies per month

Source: ASIC, Australian insolvency statistics

Survival rates have fallen for smaller and medium-sized businesses. The survival rate for businesses with annual turnover below $50,000 fell from 78% in 2018 to 48% in 2021. Similarly, businesses with turnover between $50,000 to $200,000 recorded a 64% survival rate in 2021, down from 87% in 2018.

Though the number of businesses exiting the market jumped in the second half of 2021, they remained below the business entry rate, meaning the total number of Australian businesses continues to grow. Indeed, the gap between entries and exits from the market has widened since late 2021, suggesting the disrupted economic environment has actually been good for start-ups.

That said, while business counts are up overall, the tight labour market, rising interest rates and slower growth forecasts are expected to weigh on new business formation in late 2022. 

Chart 2: Entries and exits of Australian businesses (000s)

Source: ABS, Counts of Australian businesses

By state, Victoria fared better than other eastern states over the June quarter, with a 17% increase in insolvencies compared to the same period last year. But not all major states were as fortunate. New South Wales and Queensland saw insolvencies rise by 27% and 34% respectively, with numbers possibly higher due to flooding in those states. Insolvencies fell 4% in Western Australia on the back of strong economic activity and record high commodity prices.

Strong consumer spending at the start of the year helped businesses remain afloat in the larger states, but this support is giving way as inflationary pressures mount on companies and consumers.

By sector, insolvencies in health care and social assistance doubled over the year to June 2022, with the COVID boom for the industry beginning to fall off. The professional services, administrative and support services, and utilities sectors have also seen more insolvencies, compounded by skill shortages.

An increasing number of developers, builders and contractors are also entering external administration, squeezed by rising costs, supply shocks and labour shortages. While the construction sector has seen a rapid increase in insolvencies, including some high-profile ones, the overall rate of business failure in mid-2022 had only returned to pre-COVID rates.

Companies nearing insolvency have been known to transfer business to a new company and leave old debts behind (illegal phoenix activity), creating risk for creditors. ASIC has drawn attention to greater enforcement of debt obligations over the last few years to reduce such instances.

The improved enforcement of debt obligations may even help improve business credit, bolstering the post-inflation recovery once Australia gets through current challenging economic conditions. However, with interest rates likely to rise further, and economic growth set to slow over the next year, those challenging conditions may be with us for some time.