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Insolvency Test
You may think that being under cashflow pressure is not the same as being
insolvent. This is not true! Inability to pay debts on time is a definition
of insolvency - see below.
It is vitally important to understand that, if the business is insolvent,
this results in a shift in the soletrader’s duty of care from acting for the
business to ensuring the creditor’s position is maximised.
Use this page to establish if the business (and therefore yourself) is
insolvent.
So how do you know if the business is insolvent? How can you tell if you are
insolvent even if the business appears sound? 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
business is insolvent or not.
There are three methods to determine insolvency
1. The Cashflow Test.
1.1. Simply - can the business pay its debts when they fall due for payment?
For example if you employ people and 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 business could be
insolvent.
1.2. If your trade creditors sell to you on say 30 days terms and you
regularly pay on 90+ days, then the business could be insolvent.
1.3. If you believe that the business has insufficient cash to pay it’s
liabilities on time then you must take advice/action.
2. The Balance Sheet Test
2.1. Simply - do you owe more than you own as a business or are the
business’s assets exceeded by its liabilities?
2.2. Do you owe more than you own personally? If yes, to either, then
insolvency is a probability.
2.3. It is important to point out that this test should include contingent
or future liabilities. (If you need advice on these issues call or email
us).
2.4. Many people tell us that on a balance sheet test the business is not
insolvent therefore they do not need to act. However, under the cashflow
test above the business may, of course, still be insolvent.
2.5. 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.
2.6. So be prudent - you should present accounts to show a true and fair
picture of the business.
3. Legal Action Test
3.1. If a creditor has obtained a County Court Judgment against either the
business name or in your name, this may demonstrate the business’s or the
individual’s insolvency and the creditor may seek to recover this debt via
the bailiffs or the Court may demand that you attend to examine your
financial means, or the creditor may petition for bankruptcy proceedings.
3.2. 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
make you bankrupt.
If you believe that any of the above tests are positive for your business,
it is vital that you 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 you are insolvent you must act to maximise creditors interests.
If there is no reasonable prospect of the following happening:
1. 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;
2. A sale or acquisition of the business assets;
3. An individual voluntary arrangement, trust deed, refinancing or trading
out;
then you may face personal bankruptcy.
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