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What are the warning signs of an insolvent company and the insolvency test?

When directors are caught up in the day-to-day running of their company, it is very easy to miss the signs of approaching insolvency. You may just accredit cash flow problems to an inefficient department or function of the business, rather than take a wider view of operations as a whole.

If you are experiencing one or more of the problems described below, you may need to seek guidance on company insolvency procedures from a licensed insolvency practitioner in order to avoid further complications in your situation.

Maximum borrowing

You have reached the limit of your bank overdraft and have been refused further borrowing without providing personal guarantees. Suppliers are refusing you credit, and you do not own sufficient assets to obtain a secured short-term loan.

If company cheques have bounced, this will cause more problems with suppliers who may decide to take legal action in the form of a statutory demand.

You have no reliable management information

There are no systems in place to provide vital information about performance of the business. Cash flow forecasts, aged debtors reports, bank reconciliation's and sales forecasts are all necessary if directors are to make any decisions with confidence.

When this type of information is lacking, it is impossible to say with any certainty how much you are owed, and the extent of your debt. It is a dangerous situation for the company, as rescue options are severely limited.

Demands for payment

You may have received a Statutory Demand from a secured or unsecured creditor, or are constantly receiving threats of legal action against the company for unpaid bills. A Statutory Demand is often closely followed by a winding up petition, which could effectively mark the end for your company.

If HMRC are chasing you for payment, the company is already in the danger zone as they are relentless in the pursuit of bad debts. Penalties for late payment of tax can be significant, making a dire financial situation untenable.

Other warning signs in relation to creditors include:

• Taking an increasingly longer period of time to pay trade creditors
• Dealing with complaints by creditors, and ‘firefighting’ issues on a daily basis
• Deliveries of stock are delayed and production/sales are falling behind as a result.

No money to pay staff wages

If the likelihood of meeting the wage bill is slim, this is a sure sign that insolvency is looming. You may not have taken a salary from the business yourself for a few months in the hope that the next big sale will correct the situation, but it is very rarely the case, and once employee’s wages go unpaid your company is already technically insolvent.

These are just a few of the signs of insolvency, but there are specific tests that can be carried out to confirm the situation.

Company insolvency tests

A company is said to be insolvent if it cannot pay its bills as they fall due, or the total of its liabilities exceeds the total value of assets.

There are two tests to determine if either or both of the above are true:

Cash flow test

Being able to pay debts as they presently fall due, as well as those which fall due in the ‘reasonably near future’ is the general test for cash flow. The term ‘reasonably near future’ depends in part on the industry in which you operate, and the nature of your business.

If your creditors impose 30-day terms for payment and you regularly fail to adhere to these terms, paying only after 90 days for example, it is likely that you are trading insolvently.

This is often the first sign of potential problems, which is why regular monitoring of the company’s financial position is so important. Other strong indications of insolvency are:

• Failing to meet a 21-day Statutory Demand for payment of more than £750
• Failing to adhere to the terms of a court order or judgement.

If you are found to be insolvent but still trading, as a director you would face allegations of unlawful trading, and may become personally liable for some or all of the company’s debts.

Balance sheet test

This tests the likelihood of the value of your assets being less than your liabilities. To determine this with any accuracy you will need to appoint an independent expert to value company assets correctly, and take into account all contingent liabilities.

Should liabilities exceed assets, you would be unable to repay creditors as there would be insufficient funds even if you sold all the company’s assets. Therefore, it can be said that your company is on the verge of insolvency if the figures for liabilities and assets are comparable.

Even if this test appears to indicate that the company is solvent, the cash flow test could return a less hopeful result. That is why it is important to view the results as a whole, as well as independently.

The main advice if you find that your company is insolvent is to stop trading immediately. You have an obligation to put the interests of creditors ahead of your own in these circumstances, and if you carry on trading insolvently you could face disqualification as a director for up to 15 years.

A verdict of insolvency does not necessarily mean the end for your business, however. It is encouraging to note that a variety of formal insolvency options could turn your company around.

These include a Company Voluntary Arrangement, which may be suitable if creditors are threatening legal action, and Company Administration, whereby an administrator is appointed with a view to restructuring the company and returning it to profitability.

Begbies Traynor is the UK’s market leader in corporate recovery. We operate from offices spanning numerous UK locations and offer same day consultations free of charge.

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Advice You Can Trust

Insolvency Practitioners Association Institute of Chartered Accountants in England and Wales R3: Association of Business Recovery Professionals ICAEW Business Advice Service Turnaround Management Association ACCA (the Association of Chartered Certified Accountants) ICAS | The Institute of Chartered Accountants of Scotland