Spotting Signs of Insolvency and Managing Risks
Early signs of insolvency
It’s important to note the financial situations that may cause company insolvency and, in the worst cases, the company being wound up. This is true, even if your company’s financial situation has never been a cause for concern. An unexpected downturn in the market can easily have severe implications on your business.
A company is insolvent if it is no longer able to pay its debts as they fall due. There are various insolvency rules in place, and procedures available for an insolvent company. We have outlined those processes in our Helpful Options for Companies at End of Business Life article.
Company cash flow problems vs insolvency
Company cash flow problems aren’t necessarily an indication of company insolvency, but it’s always something to be mindful of. Many factors can cause cash flow problems, such as poor sales and a lack of credit control, and many problems are just temporary. However, it’s important to understand exactly what is causing problems, and manage your cash flow on a daily basis, detailing incomings and outgoings, to stay on top of any issues. Over time, cash flow problems will undoubtedly worsen if you don’t put any steps in place to deal with them.
If you are consistently reaching the limit of your company overdraft, or are unable to borrow money, you need to look closely at your situation. Should suppliers refuse you credit, you could be facing the early signs of insolvency. If your company regularly has to borrow money to pay creditors and staff wages etc., this is referred to as ‘ceiling borrowing’, and often suggests a company may be on the brink of insolvency.
In turn, these suppliers could cause further damage down the line, by issuing a statutory demand.
Creditors issue winding up petition
If your creditors feel that you are no longer able to pay your company debts, they can apply to the courts for a winding up petition for compulsory liquidation. The creditors only need to be owed more than £750 to submit the petition to the courts. This is typically expensive for creditors to do, and they do this as a last resort. However, if a creditor thinks they are unlikely to get paid any other way, they will be willing to incur some costs in the process. Prior to the winding up petition, it’s likely that your company will have been served a statutory demand, with 21 days to make your repayments or dispute the demand. If you don’t answer, and address the dispute or monies owing, this could effectively end your business.
If you are struggling to keep up with late payments, this could be a sign of deep-rooted problems for your company. At worst, those problems could lead you down the road of company insolvency. Those late payments can also affect your company’s credit score, which could have long-lasting consequences. Late payments suggest you are not operating within your limits and will alert the bank to look into your company’s financial situation.
Directors are not paid
Another sign of company insolvency is a director pay freeze. If a director’s wages are affected and, effectively, stopped – even for the good of the company assets – this conveys serious problems. Directors must act in the best possible interests of the creditors should their company head into insolvency.
Other signs of insolvency
There are several other reasons as to why a business may fall into company insolvency, and we have outlined some of the most common:
- Overtrading with a lack of funds and profit margin
- High staff turnover and lack of money to pay wages
- Delays in providing financial information
- Loss of major contracts
- Profit decline in particular industry
- CCJ’s, statutory demands or writs against the company
Company Insolvency Tests
If you are worried about insolvency, there are two tests to determine whether your company is deemed to be insolvent; cash flow and balance sheet. It’s important to remember a business is regarded as insolvent, due to the Insolvency Act 1986, if they cannot pay their debts as they fall.
Cash Flow Test
The ability to pay your company debts as they fall due, or in the ‘near future,’ is generally the test for cash flow solvency. If you cannot pay your debts within the amount of time provided, exceeding payment dates, then you could be deemed insolvent. If your company is said to be insolvent but still trading, you could face allegations of wrongful trading. We have outlined the possible consequences of trading while insolvent, with our recent post.
Balance Sheet Test
The balance sheet test is designed to ascertain whether your company assets are less than your liabilities. You will need to appoint someone who is independent of the company to do this. If those liabilities exceed your assets, then your company is on the verge of insolvency – even if you sold the company assets. You can find more detail on what is insolvency with our relevant post.
If you feel your company may be heading towards insolvency or at risk of the signs of insolvency, you must act fast. Our business rescue experts can discuss your financial situation and provide advice on what to do next.