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What is Balance Sheet Insolvency? Is there a test for it?

12th August, 2020
Robert Moore

Written ByRobert Moore

Marketing Manager


Rob has over a decade of experience in web and general marketing. He has extensive knowledge of the Insolvency sector and has helped many worried directors with their questions.

Rob is now working with the Board at KSA Group Ltd to develop strategic marketing programmes to support the business plan and drive more company rescues.

Robert Moore
  • What is the balance sheet test for insolvency?
  • What is the cashflow test for insolvency?
  • What should I do next?

Many believe there is just one type of insolvency; when you are unable to pay money owed on time. While this is the definition of ‘technical insolvency’, it is not the only type you should be aware of.

In fact, there are actually two types of insolvency that companies should consider and these are known as the insolvency tests:

  1. Balance sheet insolvency: This is when a company’s total liabilities outweigh its total assets.  But it may still be able to pay its liabilities when they are due.  So a company may have a big tax bill coming up, which is not due yet, but if it was then it couldn’t pay it.  A company might also be deemed balance sheet insolvent if contingent liabilities exceed its assets.  A contingent liability is one that has not as yet crystallised or been determined exactly.  The definition of balance sheet insolvency was determined in the case of (BNY Corporate Trustee Services Ltd & Ors v Neuberger [2013] UKSC 28)
  2. Cashflow insolvency: This is when a company cannot meet demands for payment as and when they are due.  It might have enough assets to pay money owed, but does not have an appropriate form of payment. In essence it could be unable sell the assets or raise cash against them quickly enough.  An example might be a property company which is asset rich but cash poor.  Of course it is likely that they may not have the assets either to cover the money owed.

However, if a company is viable it can often negotiate its way out of cash flow insolvency. Balance sheet insolvency is much harder to rectify.

At the point where you think either cashflow or balance sheet insolvency might apply to your business, you need to act with your creditors’ best interests in mind.

Determining if your company is insolvent should be at the top of your priority list. As a director, this may help you avoid accusations of insolvent or wrongful trading later on.

What is the balance sheet test for insolvency?

A balance sheet test of insolvency is simply an exercise to establish whether your company is in an insolvent state.

If the company has liabilities greater than its assets then it is balance sheet insolvent.

If a creditor has issued a winding up petition they are asking for the court to declare it insolvent. So, if creditors are trying to prove insolvency to initiate a winding-up order, they must prove the balance sheet to be insolvent.  That said a court is unlikely to wind up a company just because it is balance sheet insolvent.  It will wind it up if it can’t pay the petitioner.  Inability to pay demonstrates cashflow insolvency anyway.

What is the cashflow test for insolvency?

A cashflow test identifies if a company cannot pay its bills as they fall due, or in the “reasonably near future”. If the company is found to be cashflow insolvent, then it may be wound up under the Insolvency Act of 1986.

What the “reasonably near future” is varies according to industry and the commercial circumstances specific to each case.

However, the test has some flaws. The longer the time period used in the cashflow test, the more hypothetical the result becomes. Meaning, it’s not entirely reliable as it’s purely speculative. Therefore, the balance sheet test is often the only sensible test for determining insolvency in the long term.

There is a third test called the “Legal Actions Test” which is used by insolvency practitioners although it is in reality an extension of the cashflow test.  If a creditor has launched legal action to recover the debt then it is demonstrably unable to pay its creditors when they are due.

What should I do next?

It’s surprisingly easy to come to an incorrect outcome when trying to ascertain balance sheet insolvency. Many companies often discover far too late that an error was made, and their company is technically insolvent.  This might be failure to account for VAT properly, overestimate the value of stock,

A common mistake is over-estimating asset figures, so it’s important to get accurate valuations at the start of the process.

Contingent liabilities are often left out of calculations, meaning that a true and fair view of the business isn’t presented.

To avoid this, we would suggest bringing in financial and insolvency experts to help you determine whether your company is insolvent. Not only can they give you a clear and definitive answer, they can also suggest viable solutions such as administration, voluntary liquidation or CVAs.

To find out if your company is insolvent, talk to our experts at Company Rescue today.

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What Is A Winding Up Petition By HMRC or Other Creditor

A winding up petition is a legal notice put forward to the court by a creditor. The creditor petitions to the court if they are owed more than £750 and it has not been paid for more than 21 days. The application, in effect, asks the court to liquidate the company as they believe the company is insolvent.

What Is A Winding Up Petition By HMRC or Other Creditor

Notice of Intention To Appoint Administrators

A notice of intention to appoint administrators is when the company files a document to the court to outline that it intends to go into administration if a solution cannot be found to its immediate financial problems. It can be used as part of the pre-pack administration process as well as used to restructure a failing business to avoid its liquidation.

Notice of Intention To Appoint Administrators
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What Does Going Into Administration Mean?

Going into administration is when a company becomes insolvent and is put under the control of Licensed Insolvency Practitioners.  The directors and the secured lenders can appoint administrators through a court process in order to protect the company and their position as much as possible. Going Into Administration - A Simple Guide Administration is a very powerful process for gaining control when a company has serious cashflow problems, is insolvent and facing serious threats from creditors. The Court may appoint a licensed insolvency practitioner as administrator. This places a moratorium around the company and stops all legal actions.The administration must have a purpose and the Government encourages the use of company rescue mechanisms after administration. The 3 purposes (or objectives) of Administration Rescuing the company as a going concern. (Note: this purpose is to rescue the Company as opposed to rescuing the business undertaken by the Company.)Company rescue as a going concern – this is usually a  company voluntary arrangement. The company enters protective administration and is then restructured before entering into a CVA. The CVA would set out proposals for repayment of debts to secured, preferential and unsecured creditors. When the company has its CVA approved by creditors, then the administration process comes to an end after 28 days. Achieving a better result for the company's creditors This is as a whole than would be likely if the company was to be wound up (liquidation) See the differences between Administration and Liquidation.  This better result is usually obtained by selling the BUSINESS as a going concern to one or more buyers. The company and the debts are “left behind”. The better result may include securing transfer or employees under TUPE, as well as selling goodwill, intellectual property and assets. Controlling and then selling property/debtors. This is called realising assets. Then the administrator makes a distribution to one or more secured or preferential creditors, in order of creditors priority. Usually the business ceases trading and employees are made redundant.Only if the first two options are deemed unattainable, can the administrator use this third option.Under the administration option, it is possible for the company and its directors (or a creditor like the bank) to apply to the court to put the company into administration through a streamlined process.However, the law requires that any finance provider (like a bank or lender), with the appropriate security, is contacted and the aims of the administration be discussed and approved. The finance provider must have a fixed and floating charge (usually under a debenture) and the charge holder will need to give permission for the process to go ahead. Five days clear notice is required.  Be aware, though, that a secured lender can appoint administrators over a company without notice if it thinks its money is at risk.  So communication with the secured lender is essential.  

What Does Going Into Administration Mean?

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