Is your company insolvent, take this simple insolvency test

It is vitally important to understand that, if the business is insolvent, this results in a shift in the director’s duty of care from acting for the shareholders to ensuring the creditors position is maximised.

Use this page to establish if the company is insolvent . See introduction for how to use the rest of this site

So how do you know if the business is insolvent? By now you will have studied the warning signs pages and learned that apparently insignificant issues can lead to business failure when combined. This page will tell you whether the company is insolvent or not.

There are three methods to determine insolvency

1. The Cashflow Test.
Simply - can the company pay its debts when they fall due for payment? For example if you are not paying the deductions from employees for NIC and Income Tax across to the Inland Revenue on the 19th of the month after the month they were deducted, then the company could be insolvent.

If your trade creditors sell to you on say 30 days terms and you regularly pay on 90+ days, then the company could be insolvent.

A director has a legal requirement to understand this issue. If he or she believes that the company has insufficient cash to pay its liabilities on time then they must take advice/action.

2. The Balance Sheet Test

Simply - do you owe more than you own as a company or are the company’s assets exceeded by its liabilities? If yes, then the company could be insolvent.

It is important to point out that this test should include contingent or prospective liabilities. (If you need advice on these issues email us).

Many directors tell us that on a balance sheet test the company is not insolvent therefore they do not need to act. However under the cashflow test above the company may still be insolvent.

In our experience an apparently solvent balance sheet may include items that are overstated, such as stock and work in progress, or debtors that are not really collectable. After deducting these items many balance sheets become insolvent. So be prudent - you are legally required to present accounts to show a true and fair picture of the business.

3. Legal Action Test

If a creditor has obtained a County Court Judgment, this may demonstrate the company’s insolvency and the creditor may petition to wind up the company. (See compulsory liquidation).

If a creditor has obtained a statutory demand for greater than £750 and it remains unpaid for more than 21 days, then the creditor may petition to wind up the company. (See compulsory liquidation).

If you believe that any of the above tests are positive for your business, it is vital that you and the board of directors take action to address the insolvent position. However, don’t panic, look carefully at all pertinent issues and consider the rest of this website.

Remember, if the company is insolvent you must act to maximise creditors interests. If there is no reasonable prospect of the following happening:

New or additional capital or finance being introduced to the business to return the balance sheet to a solvent position or to remove the cashflow pressures.

A sale or acquisition of the company

A company voluntary arrangement or administration

then the directors may be accused of wrongful trading. If you are worried about this or your accountant has said he/she is concerned then look carefully at directors disqualification

INSOLVENCY TEST