Borrowing against property to keep a business running is dangerous - and too common, expert says.

Many of the companies producing about a third of New Zealand's GDP are sitting on a debt and cash flow precipice, according to insolvency experts.

Small-to-medium enterprises (SMEs) are productive engines of the New Zealand economy: 97 per cent of all businesses have 20 employees or less, they provide jobs for roughly a third of all Kiwis and produce about 29 per cent of our GDP (about $53 billion).

But Jessica Kellow, recovery and insolvency partner with business advisory firm BDO, says recent years of stable economy have given many such businesses a false sense of security.

BDO's practice has been among those which have noticed that the last three to four years have been "quiet" on the insolvency and liquidation front.

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"That is a reflection of the strength of the economy," she says, "but in some circumstances, it appears to have been masked by the property market which has risen so sharply in our main centres, like Auckland, Wellington and Tauranga.

"The rising value of property assets has enabled banks to extend more credit to companies; they are comfortable with lending against directors' personal properties.

"But the downside of that is that many companies have not had to face up to financial and management difficulties that may be affecting their company – but which is covered up, for the time being anyway, by an injection of finance connected to their personal assets."

The main problem, she says, is predicted rising interest rates and the effect on cash flow: "Many SMEs are very good at their trade but not so good at managing the business.

"An important aspect of managing cash flow is the collection of accounts receivable. The good old days of being paid on the 20th of the month are history for many – a lot of customers are stretching that out to 60 days and sometimes more," she says.

The problem will be exacerbated if, and more likely when, currently friendly interest rates begin to rise. Then, says Kellow, businesses which have underlying cash flow problems will find themselves with dangerously high levels of debt based on extended asset values.

"Typically, what happens next is that the banks' lines of credit dry up," she says. "They won't extend credit and then companies running negative cash flows will be exposed – trading can come to a halt very quickly."

Kellow says she is working with one company which had put significant money and effort into research and development. However, a lack of sufficient sales resulted in mounting liabilities. Another client, in a bid to keep up with competition and "keep up with the Joneses", had developed many products – but failed to analyse which were the most profitable.

"There will always be one-off issues – like losing a major client – or systemic issues like staffing in the construction industry or bricks-and-mortar retailing battling against online shopping."

But many New Zealanders running SMEs do not keep a close eye on basic management processes, she says: "It is very easy, perhaps the easiest country in the world, to start a business here. Entrepreneurial attitudes are great but there is not a lot of consideration given to managing the business properly."

That is part of the reason why some statistics suggest one in five businesses do not survive their first year, only two thirds make it through their second and only 30 per cent survive through to 10 years.

Cash flow will always be a battle and she noted British attempts to legislate so companies received payments on time. This is being demanded in the wake of the Carillion construction company collapse earlier this year. Over 60 per cent of Britain's small businesses are demanding new laws to crack down on a late payments culture that causes thousands of companies to go bust every year – asking for forced payment of bills within 45 days.

"That measure has worked well in the New Zealand construction industry," says Kellow, "but the main problem about introducing that across the board would be enforcement. It's a big step."

In the meantime, she recommends addressing the financial base of the company if debt ratios are high, plus the following measures:

• Look at costs: "That is everyone's first thought but it may not address the underlying viability of the business."
• Improve debt collection or stop credit: "The latter is not used widely enough in New Zealand".
• When times are tough, marketing should be "front and centre" as well as finding new lines of revenue.
• Think about external governance: "New Zealanders are not very good about seeking advice and it doesn't have to be expensive.
• A possible restructure – consider hiving off the core business or a formal insolvency regime to protect the value of the business now, rather than a year or two later when equity has been well and truly eroded.

For more information: www.bdo.nz/bri