A company has a cash flow problem when it cannot meet its bills from the cash it has on the day they fall due. That can happen to a profitable business. It is also, in law, the first test of insolvency, which is why the diagnosis has to come before the fix.
This page is about diagnosis: where the cash is going, and whether the shortfall is a timing gap or a sign the company is insolvent. If you already know the shortfall is serious, go to what to do in a cash flow crisis.
Cash is not profit
Cash flow is the money moving in and out of the business: customer receipts in, and wages, suppliers, rent, loan repayments and tax out. Profit is an accounting measure. Cash is what pays the wages on Friday.
A company can book a profitable sale in March and not be paid for it until June, while its own suppliers, payroll and VAT fall due in between. Fast-growing companies are the most exposed, because they pay for extra staff, stock and premises before the income from the extra sales arrives.
Where the cash usually goes
Most shortfalls trace back to a small number of causes. Each one comes with a question that tells you whether it applies to you.
- Customers pay slowly. Compare the days your customers actually take with the days you give your own suppliers. If customers take 75 days and you pay in 30, your bank balance is funding the gap. For business customers, an agreed payment period longer than 60 days is allowed unless it is grossly unfair to the supplier, in which case statutory interest runs from the end of the 60-day period. Where no date is agreed, payment is late 30 days after the invoice or delivery, and you can charge interest at 8% above base rate.
- Overheads have outgrown sales. Rent, software, insurance and professional fees tend to rise in steps and rarely fall on their own. Check each against the revenue it supports.
- Tax is being used as working capital. VAT and PAYE are collected for HMRC. Using them to pay other bills defers the problem and adds interest at Bank Rate plus 4%. In an insolvency, these debts also rank ahead of ordinary unsecured creditors.
- Debt costs more than the business earns. Short-term, high-cost borrowing taken to fill one gap often creates the next one.
- Stock sits on the shelf. Stock that is not moving is cash the company cannot use, and it costs money to store.
- Customers do not pay at all. A single bad debt from a large customer can wipe out a smaller company’s reserve. Credit checks and deposits cost less than the write-off.
- Nobody can see the numbers. If the company cannot produce an aged creditor list and a cash forecast today, it cannot manage its cash, and it cannot show later that the directors did.
Sectors where the gap is built in
Some businesses carry a cash gap as part of how they trade. That does not make a shortfall safe. It means the forecast has to be tighter.
- Construction: long payment chains and retentions mean subcontractors pay for labour and materials long before they are paid.
- Recruitment: agencies pay temporary workers weekly but invoice clients on longer terms.
- Wholesale and distribution: large orders come with demands for longer credit, on thin margins.
- Manufacturing: raw materials, stock and work in progress all tie up cash before a sale is made.
- New companies in any sector: they pay set-up costs before they earn anything and have no reserve to fall back on.
Timing gap or insolvency? Three questions
The distinction matters because the law treats the two differently. Ask these in order:
- On a realistic week-by-week forecast, can the company pay its debts as they fall due over the next three months?
- Are its total liabilities, including those that fall due later, more than its assets are really worth?
- Is the gap closing month on month, or widening?
A no to the first question, or a yes to the second, is a strong sign the company is, or may be, insolvent under section 123 of the Insolvency Act 1986, which asks whether it is unable to pay its debts as they fall due or its liabilities, including contingent and prospective ones, exceed its assets. The three-month forecast is a practical check, not a period set by the Act. A widening gap suggests it soon will. Our guide to checking whether a company is insolvent takes each test in turn.
What an insolvent position means for you as a director
Your duty is still owed to the company. But once you know, or ought to know, that it is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable, you must weigh the interests of the creditors as a whole. That is the effect of BTI 2014 LLC v Sequana SA [2022] UKSC 25.
A director who keeps trading after there is no reasonable prospect of avoiding insolvent liquidation can be ordered to contribute personally under section 214 of the Insolvency Act 1986, and can be disqualified for up to 15 years. If the company goes into liquidation, the liquidator must report to the Secretary of State, through the Insolvency Service, on the conduct of everyone who was a director at any time in the three years before the company went into liquidation. The report is not limited to the months a cash forecast covers, but a sound forecast is evidence of how you managed the company. See directors’ duties when insolvent and when directors become personally liable.
What to do with the diagnosis
If the problem is timing, the fix is operational: collect faster, spend less, and agree terms with the creditors who matter before they act. Seven steps for a cash flow crisis sets them out in order.
If the company is insolvent, the main formal routes need a licensed insolvency practitioner, whether that is a company voluntary arrangement, which needs the approval of three-quarters or more by value of the creditors who vote (it is not approved if more than half by value of the unconnected creditors, meaning all those whose claims are admitted for voting, whether or not they voted, vote against it), or administration. The earlier that conversation happens, the more of those routes are still open.
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