A company becomes insolvent when it is unable to meet its financial commitments due to a shortage of cash, or when the total value of its assets is less than the money it owes any creditors. Either scenario can ultimately lead to the winding down of a business, which is why it’s important to spot the warning signs of insolvency before it’s too late.
The Common Warning Signs of Insolvency Are:
- Overtrading (lack of capital to pursue growth strategy, declining profit margins)
- Accrued debts with HM Revenue & Customs
- Significant bad debts & ageing debtor ledger
- Terminal bank overdraft position – continually at the limit
- High staff turnover
- Delays in producing and providing financial information when requested
- CCJ’s, Statutory Demands or WRITS registered against the Company
- Loss of major contacts resulting in cash flow crisis
- Constantly receiving red-top letters from creditors
- Bailiffs attending to pursue unpaid debts
Three Tests of Company Insolvency
If your Company is encountering financial pressure and you are unsure whether the Company can meet its commitments as and when they fall due, your Company may be technically insolvent. Three test of solvency are:
1. BALANCE SHEET TEST
This test assesses whether a business is insolvent on a balance sheet basis, i.e. does the total sum of money owed to creditors (liabilities) exceed the total value of the company’s assets? If your company’s liabilities exceed the value of its assets, it means you’ll be unable to repay your creditors because there would still be insufficient funds even if you sold all of the company’s assets. You will need to appoint an independent expert to ensure this test is completed accurately.
2. CASHFLOW TEST
Can your business meet its financial commitments as and when they fall due, or in the ‘near future’? Late or overdue payments to creditors are indicative of a poor cash flow situation, and a sign that your company may be trading insolvently. This could lead to accusations of wrongful or unlawful trading which, if proven, may make your company’s directors personally liable for the payment of any outstanding debts. It could also see them disqualified as a director for up to 15 years.
3. LEGAL ENFORCEMENT TEST
Have any of your company’s creditors obtained judgement for the recovery of debt? Are there any outstanding statutory demands that have not been set aside? Both of these scenarios are strong indicators of company insolvency, demonstrating a failure to repay creditors at, or near, the time that payments were due.
Expert Insolvency Advice
The exact point at which a business becomes insolvent is not determined by one single factor but by a range of circumstances specific to each company. It is therefore important that clear, independent advice is sought at the earliest opportunity to enable as many restructuring and recovery options as are available.
As outlined above, a business can be comfortably solvent on a balance sheet basis yet suffer from a poor cash flow position, rendering the company illiquid and unable to settle its liabilities as and when they fall due.
In all circumstances, Parker Andrews can help – contact one of our Insolvency Practitioners for a confidential discussion about your situation.