Written by Jonathan Munnery, Insolvency & Restructuring Expert | Last updated: 1 October 2025 | Reading time: 6 mins
What is insolvency?
Limited company insolvency is a financial state in which a business cannot pay its debts. There are two tests you can do to determine whether your company is insolvent:
- The cash flow test - Can your company pay its bills when they become due?
- The balance sheet test - Does the value of the business’s assets exceed its total liabilities, including the liabilities you expect to arise in the future?
If the answer to either of these questions is no, your company is technically insolvent. At that point, you must seek professional advice.
What is the difference between insolvency and bankruptcy?
Bankruptcy
Bankruptcy is a formal legal process for individuals who cannot pay their debts. When they reach a point where they can no longer meet their financial obligations, they can apply to the court to be ‘declared bankrupt’. Bankruptcy is the process that helps them manage and eventually discharge their debts.
Sole traders and ordinary partnerships can become bankrupt when their businesses fail. That’s because there is no legal separation between the business’s finances and the finances of the individuals who own and operate it.
Insolvency
If you run a limited company that cannot pay its debts, it is considered insolvent. In this case, there is a legal separation between the company and its owners. The company is insolvent, but that does not automatically affect the personal finances of its directors or shareholders, provided they have acted lawfully and responsibly.
Unlike bankruptcy, you do not ‘declare’ your business insolvent in the same way an individual declares bankruptcy. However, once a company becomes insolvent, its directors have a legal duty to act in the best interests of their creditors. That usually means ceasing to trade immediately and seeking professional advice to either rescue or liquidate the company.
What is the process to ‘declare’ your company insolvent?
If you believe your company is insolvent, there are certain steps you must take to protect the interests of its creditors and avoid becoming liable for its debts.
Step 1: Recognise the warning signs of insolvency
The first step is to recognise that the company is actually insolvent. As well as the two insolvency tests, there are also several day-to-day warning signs to look out for:
- Relying on debt to pay your bills
- Struggling to pay employees
- Using personal funds to pay company debts
- Reaching the limit of your overdraft and being refused further borrowing
- Receiving formal payment demands from creditors and threats of legal action
- Consistently lacking the cash flow to run the company properly
- Having an HMRC Time to Pay Arrangement in place but still struggling to pay your tax debts
Step 2: Seek professional advice
If you think your company could be insolvent, contact a licensed Insolvency Practitioner immediately.
At UK Liquidators, we offer free, confidential insolvency advice to help you understand your situation and explore your options. We will assess your business’s finances, explain your options and recommend the most appropriate route to take.
If the company is insolvent, we will usually advise you to cease trading immediately, unless continuing to trade will benefit the creditors. We’ll also guide you through your legal duties as a director and help you act in a way that protects your position and minimises the risk of adverse consequences.
Step 3: Decide on a way forward
The most appropriate solution for your company will depend on its financial position and the viability of its underlying business model.
- Informal rescue methods - If the company is insolvent but its financial issues are temporary or manageable, exploring solutions such as Time to Pay Arrangements, informal payment plans with creditors and refinancing could give the business a way forward without entering a formal insolvency process.
- Company Voluntary Arrangement (CVA) - If your business has a good prospect of making a recovery and you still have an appetite to run it, it may be possible to make a Company Voluntary Arrangement with your creditors to repay what you owe in monthly instalments over time.
- Administration - If the company is in severe financial distress, but there’s still a chance to rescue the business or sell it as a going concern, Administration could be an option.
- Creditors’ Voluntary Liquidation (CVL) - If the company is beyond recovery or you no longer want the stress of running it, Creditors’ Voluntary Liquidation could be in everyone’s best interests. The company will be closed, and any debts it cannot repay will be written off, as long as you have met your legal duties.
What happens when you liquidate an insolvent company?
If you decide to liquidate your insolvent company, you can do so voluntarily by appointing an Insolvency Practitioner. Acting as the liquidator, they will take control of the business and wind up its affairs.
As part of that process, they will value and sell its assets, and use the proceeds to repay the creditors in a strict order of priority. They will then remove the company from the official register at Companies House, and any remaining unpaid debts are usually written off.
However, there are exceptions when the directors could become personally liable for the debts the company cannot repay. That includes the misuse of company funds, wrongful trading and fraudulent trading. You may also face personal liability issues if you have signed a personal guarantee for company borrowing or have an overdrawn director’s loan account.
What happens after you liquidate an insolvent company?
As part of the liquidation procedure, the Insolvency Practitioner will investigate the reasons for the company’s failure and your conduct in the running of the company. If they find that you met your legal duties, there’s nothing to prevent you from starting a new company in the future. You may also be eligible to claim director’s redundancy pay.
If they find that you breached your duties, for example, by continuing to trade while insolvent or prioritising your own interests over those of the creditors, you could face serious consequences. That may include a fine, being made personally liable for company debts or being disqualified from acting as a director for up to 15 years. You could even face a prison sentence in the worst cases of fraudulent trading.
Expert support for insolvent businesses
If you’re worried that your company is insolvent, we provide a free, same-day consultation to assess your finances and guide you through your options. We can also implement formal insolvency procedures to rescue or liquidate your business. Please get in touch or arrange a meeting at one of our 100+ offices throughout the UK.
