How do I know if my company is insolvent?

How do I know if my company is insolvent?

November 26, 2021

There may be many reasons why a business owner or director continues to trade a distressed business rather than seeking professional assistance. In the present circumstances, where government support has propped up businesses, it may even be the case that your company has become insolvent without you realising it. As our recent article on the state of Scottish businesses outlines, this scenario could be widespread. The issue for company directors in this situation is that insolvency legislation is precise on when a company should cease trading and, in order to avoid personal liability or sanctions, directors must seek appropriate advice as to what steps are required for their business going forward.

Where a solicitor or accountant can provide assistance on the process of insolvency, an insolvency practitioner (IP) will formulate the most appropriate strategy to assist the business owner. An IP will consider and follow the legislation, but, at the same time, they will investigate all available insolvency and restructuring options, whilst taking into account individual circumstances. This is why seeking advice as early as possible can keep all the options on the table for business owners and maximise your chances of a successful outcome.

In terms of insolvency legislation, there are two main legal tests to decide if your business is insolvent. These tests are important, particularly as they define the point when your duty of care is owed to the creditors of the business first and foremost.

If you mishandle creditors and let the financial position of your business deteriorate, you can be liable for wrongful trading or a misfeasance claim. A misfeasance claim is a catch-all claim for breach of your duties as a director under the Companies Act. As such, you should always act with those duties in mind.

Cash flow test

This simply means the inability to pay your debts as they fall due for payment. There are many reasons for cash flow issues and some of these points below can be indicators of cash flow difficulties:

  • you are being pursued for payment by various creditors and cannot afford to pay them all on time.
  • receiving multiple Statutory Demands for payment with Sheriff Officers at the door
  • you have asked to defer tax payments such as PAYE or VAT.
  • increasing your overdraft or borrowing constantly on, or just below your bank limit.
  • you consider a sale and leaseback of certain assets to raise funds
  • a significant increase in costs or turnover will drain available cash
  • a significant decrease in turnover, below breakeven will lead to cash under strain

Given the present challenges companies are facing, directors need to be extra vigilant and regularly revisit their cash flow projections and assumptions. If matters are critical then accurate and up-to-date financial information needs to be reviewed regularly to reveal any adverse trends and allow you to take early remedial action where possible.

Balance sheet test

Reference to the balance sheet will reveal if your business’s liabilities exceed its assets and if so, then you can conclude that your company is insolvent. Simply put, there are insufficient assets to cover payment in full of all liabilities. Share capital should not be included for the purposes of this calculation. Although, it is often the case that it can be many months after year end before the accounts are signed off and an accurate assessment can be made, in reality, with today’s cloud-based accounting software, the true position of a business can be assessed very quickly.

It is the responsibility of all directors to understand the company’s financial position, and be alert to cash flow difficulties and all other material trading issues. Business owners and directors can be made personally liable for the company’s debts if their actions amount to a deterioration in the creditor’s position. Directors can also face up to 15 years disqualification by the Insolvency Service if found to have wrongfully traded.

This is why if a business fails either of the above tests, the business owner or director must take positive action and quickly.

If you believe your business could be impacted by these issues and you would like to arrange an initial meeting to discuss the best way forward, contact us at your nearest local office to arrange a no obligation and confidential call with one of our Partners. Our ethos has always been to engage with those facing difficulties with a constructive and positive attitude.

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