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Insolvency Test for the Sole Trader

28 June 2019

Insolvency Test for the Sole Trader

Am I, as a sole trader, insolvent?

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 sole traders duty of care from acting for the business to ensuring the creditors position is maximised.

Use this page to establish if the business (and therefore yourself) is insolvent.

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 its 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 (CCJ)against either the business name or in your name, this may demonstrate the business or the individuals 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, you may face personal bankruptcy:

  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.
A Worried Director

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