You are an accountant working for the restructuring and insolvency firm Turnaround and Insolvency Business Experts ("TIBE").
Your supervisor has provided you with a file on Deluxe and Delicious Wines Pty Ltd ("DDW"), a company that specialises in the warehousing and distribution of select wines that is experiencing financial difficulty. Samantha Smithers is Managing Director of DDW. She has approached TIBE as she is concerned the DDW is trading whilst insolvent. She seeks your advice as to what options the company has, whether the company is likely to be placed in external administration and what actions (if any) should she take as the Managing Director of DDW.
On receiving the DDW file you carried out some initial investigations of the company, including its operating environment and overall financial position.
You have completed your investigation on 5 April 2017. Your investigations revealed the following information:
DDW History and Business Model
DDW is a small, family owned business, established by Samantha's grandfather. For many years, the company has successfully operated a warehouse and distribution service for Australian producers of fine wine. There are three directors on the board of DDW: Samantha, her brother David Smithers and George Trinket who is a family friend and has worked for the company for the last 20 years.
The company's business model has been that the company purchases the wines directly from the wine makers, particularly the smaller, more elite, wine producers that were not able to warehouse and distribute their own products. Once purchased, DDW would store and then sell the wines to retailers at a margin of approximately 40% per order. In most cases this covered the costs of the order and a sizeable profit. Historically 80% of the orders were in the Brisbane and surrounds area with the remainder in various locations around Queensland and northern NSW.
This business model has been successful in the past, but the company has been experiencing declining profits in recent years.
Factors Impacting DDW Profitability
Your general investigation has suggested the following factors have been impacting DDW's profitability:
• The company carries out its own distribution which carries fixed costs associated with ownership of transport trucks. Distribution staff are employed on a full time basis. Samantha estimates that the variable costs of distribution are $5-$35 depending on the location of the order. Increasingly, orders are being placed by customers outside Brisbane and surrounds, meaning that the variable costs are escalating.
• Customers having indicated that it is often cheaper for them to purchase the wines via internet services, such as eBay, and often with a faster turnaround on orders.
• There is a competitor company that operates a similar business in Sydney. This company appears to be increasingly focussing on distribution in the northern NSW area.
DDW Financial Information
• The company had been experiencing a high turnover of administrative staff, particularly in the accounting department. Therefore, it was difficult to determine accurate financial information. However, your investigation established that the company had the following assets and liabilities:
| Assets and Liabilities |
$ |
| Debtors (30 day terms) |
1,350,000 |
| Plant and equipment |
4,500,000 |
| Inventory |
400,000 |
| Creditors (30 day terms) |
2,140,000 |
| Overdraft |
150,000 |
| Bank Loan |
4,000,000 |
• The company pays approximately $200,000 per month for rent for the building in which the warehouse and office operates. The building is located in an industrial area in the northern suburbs of Brisbane. Similar building spaces in areas of the Sunshine Coast are cheaper, but relocation costs would be significant.
• In August 2016, David's son, Rupert, announced that he was getting married. As an engagement gift, David caused DDW to purchase a new car valued at $50,000, which was then provided to Rupert.
• One of DDW's major creditors is BoxesCo Pty Ltd, a company that supplies DDW with packaging for the wines. On 20 February 2017, BoxesCo validly served a statutory demand for an outstanding debt of $350,000 under s 459E of the Corporations Act 2001. It appears BoxesCo has been seeking payment for several months but DDW believes that it only owes Boxes Co $290,00. By the time your investigations were complete, DDW had still not paid this amount. However, DDW has not, as yet, applied to have the statutory demand set aside.
• DDW has been selectively paying creditors, and the company regularly obtains extensions for money due to the ATO.
• The bank loan and overdraft have been secured by a circulating security interest over the whole of the business and its assets. DDW has mostly been meeting its loan obligations but has been late with payment on several occasions over the last 12 months. The overdraft limit is set at $150,000. DDW had requested an increase to the overdraft in December 2016, but the bank refused this request.
• Approximately 20% of the inventory is obsolete due to damage to the stock.
You are required to:
Provide a memorandum of advice to your supervisor, Ms Jennifer Jones, on the following:
1. Whether the facts provided indicate that the company is insolvent. In your answer explain the meaning of insolvency for the purposes of the Corporations Act 2001. Include in your discussion any relevant financial analysis.
2. What external administration and turnaround options might be available to the directors of DDW based on the facts that you have been provided. You may include formal and informal options in your advice. You should provide advice all issues related to external administration that arise on the facts above.
3. Whether there is any further information that you believe you require from DDW in order to provide a meaningful report on the company's circumstances.