How do I know if my company is trading insolvent?
While it is natural for businesses to experience minor financial hiccups throughout its lifetime, regularly run out of funds and failing to meet payment deadlines as and when they fall due could point towards the company running the risk of becoming insolvent.
As a company director, you have certain legal duties and responsibilities; one of these is acting in the best interest of all stakeholders at all times, and this includes creditors. If you believe your company may be at risk of becoming insolvent, there are two main tests which can be conducted - a cash flow test and a balance sheet test. Both of these tests can assess the current financial health of the business and highlight whether the company in question may be trading while insolvent.
What is a cash flow test for insolvency?
A cash flow test measures the inflow and outflow of cash. If there is more money leaving the company than there is coming into the company, this shows that the business may be spending more funds than it actually has. If the business is unable to pay bills and other overheads in full and on time, they have failed the cash flow test.
What is a balance sheet test for insolvency?
A balance sheet is a financial statement which pinpoints the financial position of the company. It details the assets and liabilities of the business, allowing you to draw the conclusion of whether the business owes more than it owns. Assets can include cash, petty cash, supplies, land and property owned by the company.
If the liabilities outweigh the assets, the business has failed the balance sheet test. Your accountant will typically carry out the above tests in order to ensure that your business is not in arrears and trading solvent.
A solvent company will have a combination of a strong cash flow and an asset rich balance sheet. Both tests work hand in hand to distinguish between a solvent company and insolvent company.
Typical signs of trading insolvent
While the signs of insolvency can look different for every company, the common signs include the following:
- Overdraft maxed: Bank refusing to extend overdraft facility due to poor spending behaviour and bad credit
- Creditor pressure: Facing demands and threats from creditors. You may be subject to legal action and HMRC may issue fines if you have fallen into arrears
- Inability to make essential payments: Difficulty paying staff wages, rent, utility bills and other essential bills
- Legal action: The business is under threat of legal action for unpaid debts which it cannot afford to pay
If you have been issued with a statutory demand, this is a formal declaration of debt being owed. As a result of a statutory demand, the debt should be repaid in 21 days or an agreement should be reached.
A statutory demand is typically sent prior to a winding up petition which could force the business into compulsory liquidation. If you have been issued with a winding up petition, the creditor intends to wind up your company in order to have the assets liquidated and debts repaid.
A County Court Judgment (CCJ) is a court order typically issued if you are struggling to repay debts and the creditor has failed to recover the money after several unsuccessful attempts. If the debt is not paid off within 30 days of receiving the judgment, the CCJ will be issued.
What should you do if you believe your company may be insolvent?
If your business is showing any of the above signs, you may be trading while insolvent so it is best to err on the side of caution and seek advice from an insolvency expert. A company being insolvent does not necessarily mean the business is beyond rescue; there are a number of recovery and restructuring options which can be used to turn an ailing business around.
If you suspect that your business is trading while insolvent or experiencing any of the warning signs of insolvency, get in contact with your Handpicked Accountant who will be able to put you in touch with a licensed insolvency practitioner for specialist help and advice.
