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If your company is insolvent, it has serious implications for the business and its directors. That’s why, if your company is struggling, you must keep a very close eye on its financial position.
However, when you’re focusing on the day-to-day management of the company and trying to navigate out of a financial hole, it’s not always easy to spot the typical warning signs of insolvency.
Fortunately, there are two straightforward tests you can do, the cash flow and balance sheet tests, to help you determine whether your business is insolvent. Here we explain what they are, how to perform them and your options to rescue or close your limited company.
Company insolvency is a financial position where the business has more debt than it can afford to pay. As soon as you are aware, or should be aware, that your company is insolvent, you must seek professional advice from a licensed Insolvency Practitioner.
They will assess the business’s finances, including its cash flow, assets and liabilities, and determine whether the company can continue trading. You may be able to rescue the business through refinancing or restructuring. Alternatively, if it’s past the point of no return, your best option might be to liquidate.
The cash flow test for insolvency asks:
Can your company pay its debts when they fall due?
To answer this question, you need to determine whether your company has sufficient cash in the bank or assets that it can liquidate quickly, such as stock and receivables, to pay its current liabilities.
Examples of current liabilities include staff wages, supplier costs, rent, tax, utility bills and any other essentials required to continue trading. If you do not have sufficient working capital to make those payments, your operations will grind to a halt and your financial situation will quickly worsen.
If you cannot pay your debts when they fall due, your company is insolvent and you should seek advice from an Insolvency Practitioner.
The balance sheet test assesses your company’s assets and liabilities and asks:
Does the value of your company’s liabilities outweigh its assets?
To perform the balance sheet test, add the value of all the company’s physical and intangible assets. That includes everything from property, vehicles, machinery and stock to cash in the bank, your debtor book, customer lists and copyrights.
You should then compare that figure to the value of all the company’s debts. That should include long-term and short-term debts, as well as your contingent liabilities, which are the potential liabilities you are likely to incur in the future.
If your comparison shows that the value of the company’s debts is greater than its assets, the business is technically insolvent. At that point, you must explore your options with the help of an Insolvency Practitioner.
Although both the cash flow and balance sheet tests determine whether a company is solvent or insolvent, they focus on different aspects of its financial health.
The cash flow test is a practical and short-term test of a company’s liquidity. It only considers current and near-term liabilities and is a key warning of imminent and severe financial distress.
The balance sheet takes a longer-term view of a company’s overall financial position. It considers its current and fixed assets, as well as short-term, long-term and contingent liabilities. It determines the company’s overall financial position and typically indicates the requirement for restructuring and insolvency procedures.
Crucially, the company only needs to fail one of the tests for it to be considered insolvent. As an example, you may have enough cash to pay your bills, but your assets may be insufficient to cover your contingent liabilities.
If the cash flow and/or balance sheet test indicate that your company is insolvent, you should contact a licensed Insolvency Practitioner at your earliest opportunity. The sooner you call them, the more options you will have at your disposal.
The Insolvency Practitioner will assess the company’s position, outline your options and advise you on whether you should cease trading. They may recommend that you keep trading in the short term to increase the return for creditors. On the other hand, they may ask you to stop trading immediately and begin formal insolvency proceedings.
When your company is insolvent, your legal duties as a director change. Rather than acting to promote the success of the company, you must operate in the best interests of your creditors. In practice, that usually means ceasing trading to prevent the company from incurring further debts it cannot pay.
If you continue trading an insolvent company without the approval of an Insolvency Practitioner,
You could face accusations of wrongful trading. That can lead to penalties including fines, personal liability for company debts and director disqualification of up to 15 years.
Not every insolvent company is destined to fail. There are various options available to rescue or close the company depending on the severity of your situation and your willingness to continue running it.
Seek alternative finance
If your company is insolvent according to the cash flow test, finding a quick way to boost your working capital could give you more time to turn the company around. For example, invoice financing and asset-based lending can give you immediate access to the funds tied up in unpaid invoices and company assets.
That will help you cover your short-term liabilities and maintain operations while you explore long-term solutions. However, you will need to seek advice from an Insolvency Practitioner to ensure it won’t worsen your financial position.
Read more: How to solve company cash flow problems
Make an informal payment arrangement with your creditors
If your company is financially viable and has a sound business model, you could ask your creditors to extend their payment deadlines or accept payment in instalments. That will give you more time to implement a recovery plan.
The downsides are that an informal creditor agreement is not legally binding and doesn’t protect the company from legal action. It also relies on the creditor’s goodwill, which may have dried up if they have made multiple attempts to recover a debt unsuccessfully.
Propose a Company Voluntary Arrangement (CVA)
If your company has more serious or long-term debt problems, a formal insolvency procedure called a Company Voluntary Arrangement might be more suitable. It allows viable companies to enter into a legally binding agreement to repay their creditors in monthly instalments over a typical term of three to five years.
If you complete it successfully, a CVA enables you to continue trading and avoid liquidation. However, you need 75% of your creditors (by value of debt) to vote in favour of the CVA to put it in place.
Administration
Company Administration can be a good fit for larger limited companies with serious debt problems. Acting as the administrator, an Insolvency Practitioner will take control of the company and explore options to rescue or sell it.
Pre-Pack Administration is another option. It allows company assets to be sold quickly, often to the existing company directors. They can then open a new business with the old company’s assets to preserve jobs and work contracts.
Creditors’ Voluntary Liquidation (CVL)
If the company is no longer financially viable or it’s insolvent and you no longer want to run it, you can close it voluntarily using a Creditors’ Voluntary Liquidation. You must appoint an Insolvency Practitioner to administer the procedure. They will wind up the company’s affairs, sell its assets and repay the creditors as far as possible. Any debts the company cannot pay will usually be written off.
A CVL enables you to bring your company to an efficient and responsible end. It also shows that you have met your legal duty to protect your creditors’ interests, which reduces the risk of penalties.
If you’re worried your company is insolvent or have performed the cash flow or balance sheet test and found it is, please contact our Insolvency Practitioners for expert advice. We will discuss your circumstances, explain your options and advise you on the most appropriate route forward while helping to protect your interests.
Get in touch for a free, same-day consultation or arrange a meeting at one of our 100+ offices throughout the UK.
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If you are considering liquidation for your company, taking expert advice at an early stage is crucial. At UK Liquidators, our team of licensed insolvency practitioners are committed to providing limited company directors with the help and advice they need to make an informed decision.
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