For business owners, understanding when a company is insolvent is vital to making informed decisions that can either save the business or, if necessary, help you wind it up in an orderly fashion.
In this advice article, we will discuss the signs of insolvency, tests to determine if a company is insolvent, and some red flags to watch out for.
By the end of this article, you should have a better understanding of how to identify insolvency and take the necessary steps to protect your company.
Are there any tests that can tell me if my company is insolvent?
There are two primary tests that can help you determine if your company is insolvent:
- The cash flow test: A company is deemed to be insolvent if it is not able to pay back its debts as they fall due. This means that if your company cannot meet its financial obligations when they are due, it may be insolvent.
- The balance sheet test: A company is considered insolvent if its liabilities exceed its assets. This means that if the total value of your company’s debts is greater than the value of its assets, it may be insolvent.
It’s important to note that a company can be cash flow insolvent but not balance sheet insolvent, and vice versa.
It’s also possible for a company to be temporarily cash flow insolvent due to short-term liquidity issues but not technically insolvent in the long run.
(Check out this link if you want our help to dissolve your UK-based limited company).
More red flags that your company could be close to insolvency or insolvent
While the cash flow and balance sheet tests are useful in determining insolvency, there are other warning signs that you should be aware of.
Ceiling Borrowing
If your company is consistently borrowing up to the maximum limit on loans or overdrafts, it could indicate cash flow issues and potential insolvency risk.
This is especially concerning if your company is unable to reduce the borrowing or is using short-term loans to cover long-term liabilities.
NOTE – You might find this post useful. It talks about signs of a limited company failing.
Pressure From Your Creditors
Creditors becoming more aggressive in their pursuit of payments, such as issuing statutory demands or initiating legal proceedings, is another red flag.
This could mean that your company is struggling to pay its debts and may be on the brink of insolvency.
Directors Are Not Being Paid
When a company’s directors are not receiving their salaries or dividends, it could be an indicator that the company is struggling financially.
This can be a sign that the company is prioritising other payments over the directors’ compensation, which may indicate cash flow problems and potential insolvency.
NOTE – You may also find this post useful, talking about how to close a limited company.
There is No Money to Pay Staff Wages
If your company cannot afford to pay its employees’ wages, it is a clear sign that the company is experiencing severe cash flow problems and is possibly insolvent.
HMRC Contacts You
If Her Majesty’s Revenue and Customs (HMRC) contacts your company regarding unpaid taxes, this could be an indication that your company is struggling to meet its financial obligations.
Failure to pay taxes is a sign of financial distress and could result in severe penalties or even the forced liquidation of your company.
NOTE – This info about directors’ loan accounts might also be useful for you to check out.
Some Final Notes On When a Company Is Insolvent
Understanding when a company is insolvent is critical for business owners to make informed decisions and navigate challenging financial situations.
By being aware of the cash flow and balance sheet tests, as well as other red flags, you can proactively identify potential insolvency risks and take appropriate action.
If you suspect your company is insolvent, don’t delay in seeking professional advice from a licensed insolvency practitioner.
They can help you explore your options, whether that means restructuring your business, entering into a formal insolvency procedure, or finding other solutions to your financial difficulties.
CTA: If you’re concerned about your company’s financial health or suspect that it may be insolvent, don’t hesitate to reach out to our team of experienced professionals for guidance and support.
