Kevin McLeod
Written By Kevin McLeod
Licensed Insolvency Practitioner
July 24th, 2023

If your business is struggling financially, the temptation is to go on trading and creating new debts in the hope that you’ll be able to dig yourself out of a hole.

But your company could be insolvent, in which case, the Insolvency Act 1986 will apply and you must put your creditors’ interests first. Fail to do so and you could find yourself guilty of wrongful trading. 

Wrongful trading occurs when the directors of a company continue trading past the point when there’s no reasonable prospect of avoiding insolvency. The penalties for wrongful trading can be severe and include fines, personal liability for company debts and disqualification from acting as a director for up to 15 years. That’s why it’s so important to check if your struggling company is insolvent and take immediate action if it is. 

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How Do you know if a Company is Insolvent?

A company is insolvent when:

  • It cannot afford to pay its debts when they become due; and/or 
  • Its total liabilities outweigh the value of its assets. 

It’s usually the case that a business slips into insolvency gradually, rather than it being the result of a single event such as the loss of a key customer. That’s why the severity of the situation can go unnoticed and the warning signs can be missed.

The typical warning signs of insolvency include:

  • Recurring problems with cash-flow
  • Accrued debts with HMRC
  • Constant pressure from creditors
  • Creditors threatening or taking legal action
  • A high turnover of staff
  • Difficulties paying staff wages
  • Being refused credit by suppliers and finance providers
  • Delays in the delivery of stock and production or sales falling behind
  • The loss of major contracts
  • Delays in producing and providing financial information when it’s required 

In many cases, directors who see these warning signs are overly-optimistic about their company’s future. They tell themselves that it’s just a temporary bump in the road and that a new customer or a big sale will come along and solve all of their problems. However, by burying their heads in the sand and failing to take action immediately, they reduce their business’s chances of making a recovery and increase the risks for themselves.

How Do I Know If My Company Is Insolvent?

There are three tests you can do to check if your company is insolvent:

  1. The cash-flow test

Poor cash-flow is usually one of the first signs of an insolvent business. It can be the result of a market downturn, poor credit control procedures or the loss of one or more customers. Poor cash-flow will affect the day-to-day running of your business and make it difficult to grow.

The test:

  • Can you afford to pay debts that are due for payment now or that will become due in the reasonably near future?

If you are consistently making payments long after they’re due and there’s no sign of things changing anytime soon, your company is likely to be insolvent. 

  1. The balance sheet test

A balance sheet provides a snapshot of the business’s assets, liabilities and capital at a point in time. It’s important your assets are valued correctly and all of your contingent liabilities (a potential loss that may occur in the future) are taken into account. 

The test: 

  • Do your company’s liabilities exceed its assets i.e. does it owe more than it owns?

If your company’s liabilities exceed its assets, you would not have sufficient funds to repay all of your creditors even if you sold all of the company’s assets. That means the company is insolvent. If the value of the company’s assets and liabilities are comparable then the business is on the verge of insolvency.    

  1. The legal action test

If you owe a creditor more than £750, they can take legal action to recover that debt. Initially, that will take the form of either a statutory demand or a county court judgement (CCJ) being issued against the business. If the debt remains unpaid, the creditor can issue a winding up petition to close your business down.

The test:

  • Has any legal action been taken against the company that is still outstanding?

If there’s an outstanding statutory demand or county court judgement registered against your business that has not been paid, your company is insolvent. This is the case even if the debt is disputed.   

What Can I Do If My Company Is Insolvent?

If one or more of the insolvency tests indicate that your company is insolvent, it does not necessarily mean it’s the end. There are several informal and formal procedures that could help to turn the business around. 

The first step is to contact an insolvency practitioner. Contacting them as soon as you realise your company is insolvent will help to protect you from allegations of wrongful trading. They will work to minimise the losses for creditors and explore the various options and procedures available to you. If the underlying business is sound, they will explore ways to turn the company around. If the company is no longer viable then it’s in everyone’s best interests to close it down. They will help you do so in the most efficient manner. 

The options available to the directors of insolvent companies include:

  • Seeking alternative finance – If you act quickly enough, it may be possible to save the company by securing alternative finance. Options include securing finance against the value of your debtors book via invoice finance or borrowing against the business’s assets. 
  • Negotiating with your creditors – If relationships between you and your creditors are still reasonably good, it may be possible to contact your creditors to reach an informal repayment agreement. That will allow you to repay your debts while continuing to trade.  
  • Entering into a CVA – If your creditors are threatening legal action against your business, then entering into an official insolvency procedure known as a company voluntary arrangement (CVA) could be your best course of action. That will prevent your creditors from taking legal action against you and allow you to repay your debts over time.
  • Going into administration – Putting the company into administration will provide respite from creditor action and allow the company to be restructured to return it to profitability or for company assets to be sold.
  • Closing the business – If the business has no chance of survival, it’s in everyone’s best interests to close it down. A creditors’ voluntary liquidation (CVL) is usually the most effective way to close a company with debts. Its assets will be sold for the benefit of its creditors and the company will be struck off the Companies House register.      

Is Your Company Insolvent?

For more information on company insolvency or to discuss the best course of action for you, please get in touch with the insolvency practitioners at AABRS. We’ll provide a free, no-obligation initial consultation to help you take back control.