How do I know if my business is insolvent?

Knowing whether or not your business is insolvent is crucial in avoiding wrongful trading, and allows you to take the correct action according to UK insolvency laws. There are several tests that can be carried out for insolvency, any one of which may indicate a need to stop trading and place the interests of creditors first.

Cash flow

Poor cash flow is often the first sign of insolvency in a business. It affects its day-to-day running and potential to grow, and can result from a number of different scenarios - the loss of a major customer, a downturn in your market, and poor credit management procedures, are just a few examples.

What is the cash flow test?

The cash flow test is a common way to assess insolvency in business. It involves looking at whether the business can pay its bills as they fall due, and in the ‘reasonably near future.’ So if you’re struggling to find the money to pay staff wages, for example, or are consistently late in paying suppliers, you could be trading insolvently. The term ‘reasonably near future’ can vary according to the industry and type of business you run.

 

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Balance sheet

The balance sheet is a financial statement detailing all your business’ assets, liabilities, and capital. It provides a snapshot of the business as a whole, and should be a ‘fair and accurate’ representation of it at that time.

What is the balance sheet test?

This tests whether your business liabilities exceed the value of its assets, meaning that even if all business assets were sold the debts could not be repaid in full. If you have reason to believe this may be the case in your business, you should obtain professional help to value your assets and liabilities, including contingent liabilities such as pending claims against the company.

Legal action

If you owe a creditor more than £750 they’re able to petition the court to wind up your business. This is a serious situation as an unpaid statutory demand for a debt exceeding £750 officially recognises that the business cannot pay its liabilities.

What is the legal action test?

The legal action test identifies whether any outstanding legal actions against the company exist. This could be a statutory demand for payment, which often precedes a winding up petition by a creditor.

What should you do if you think your business is insolvent?

If you think your business may be insolvent you should stop trading immediately, and if you haven’t already done so, seek assistance from a licensed insolvency practitioner (IP). This action helps to protect you from potential allegations of wrongful trading, and minimises losses for creditors.

There are warning signs to look out for when you’re approaching insolvency, the most obvious usually being lack of available cash. If you act quickly enough, however, you may be able to avert insolvency by securing alternative finance – perhaps using business assets if they’re wholly owned, or the value of your sales ledger via invoice financing.

Formally negotiating with creditors is also an option, and could lead to the business entering an official insolvency procedure such as a Company Voluntary Arrangement (CVA). In the case of a sole trader, this would be an Individual Voluntary Arrangement (IVA), but both processes can help you deal with your debts and trade your way out of difficulty.

If you would like more detailed information on insolvency and how to protect your business, call our team of experts at CFS Redundancy Payments CFS are Authorised and Regulated by the Financial Conduct Authority. Authorisation No 830857. You can check our registration here.