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Who decides when a limited company is insolvent?

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Who will conduct the cash flow and balance sheet test for insolvency?

It’s incumbent on limited company directors to be aware of their company’s financial position at all times, and to understand the potential implications should their company enter a period of decline.

This is an important part of their fiduciary duties as directors, but who actually decides when a limited company is insolvent? Clearly, some input from the company’s accountant should be provided if the business declines and experiences financial distress.

This is an integral element of a company accountant’s role, and one that can help businesses pre-empt insolvency by taking early aversive action. If insolvency does occur, however, the entire operating scenario changes and priorities must be directed towards creditors rather than the company or its shareholders.

So what might indicate to an accountant or company directors that it is insolvent, or that falling into insolvency could be a real threat?

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Warning signs that company insolvency may be looming

There are a number of warning signs that can indicate insolvency. These include:

Negative cash flow

Typically, one of the first signs of insolvency is poor cash flow. This can lead to paying suppliers late on a regular basis, being unable to secure further lines of credit, or failing to pay members of staff on time.

Although poor cash flow doesn’t necessarily mean a company is insolvent, it’s certainly a factor to be aware of, as if action isn’t taken to improve cash flow – perhaps by sourcing alternative funding – the situation will worsen.

Loss of contracts

Suppliers may no longer wish to do business with the company if they’re owed money or are consistently being paid late. Similarly, if the company has overtraded and cannot afford to fund a large new contract, this is a warning sign of insolvency.

Legal action by creditors

If creditors are taking legal action against the company to recover their debt – typically via a County Court Judgment (CCJ) or a statutory demand – it’s a sign that insolvency may be close. The company only needs to owe a creditor £750 before action can be taken through the courts, and an unpaid statutory demand is a clear sign that the company is insolvent.

What does it mean when a limited company is insolvent?

If a company cannot pay its bills as they fall due, or the total value of its liabilities is more than its assets, the business may be cash flow insolvent or balance sheet insolvent and must stop trading.

Directors should seek advice from a licensed insolvency practitioner (IP) immediately to confirm the company’s financial status, but also to obtain reliable guidance on the next appropriate steps.

Depending on the professional assessment of the business’ future, this might involve restructuring, for example, seeking further funding, or entering a formal process called Creditors’ Voluntary Liquidation (CVL).

Insolvency doesn’t necessarily mean liquidation for a company, but if it cannot be avoided, it’s important that directors minimise their creditors’ losses by voluntarily placing the company into liquidation.

What is voluntary insolvent liquidation?

Creditors’ Voluntary Liquidation allows directors to fulfil their legal duty to place creditor interests first when the company is insolvent, and there is no chance of rescue. It results in the permanent closure of the company, and must be carried out by a licensed IP.

CVL offers benefits to creditors as it prevents further financial loss, but entering the process also has advantages for company directors who may avoid accusations of trading wrongfully.

Directors of a liquidated company can also be eligible for redundancy pay and other statutory entitlements if they’ve worked as employees of the company. This can provide the funds to survive without an income on a personal level, but could also be used to pay for the CVL process.

Who decides when a limited company is insolvent?

Directors should be aware that their company is experiencing financial distress to the extent that it’s close to insolvency, but a licensed insolvency practitioner will confirm this by professionally assessing the company’s affairs.

As we mentioned earlier, the cash flow and balance sheet tests for insolvency can be used, and a legal test also exists that looks at any court action being taken against the company by its creditors.

If you would like more information on limited company insolvency and liquidation, please contact our partner-led team at UK Liquidators to arrange a free, same-day consultation. We’ll also present any appropriate rescue and recovery options if your company is viable for the future.

Jonathan Munnery
Partner

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