Financial Distress
When is a business in financial distress and when is it insolvent?
This is a question often faced by business owners and company directors. There are series of financial tests that can be applied and sometimes the trigger for this question is communication from a creditor, the bank or funder or a stakeholder.
Often this begins a chain of events including getting up to date financial information about the business, securing an up to date list of assets in the business and thinking about the imminent or future cashflow needs of the business.
What is company insolvency?
Insolvency in relation to a limited company is the formal term used for when a company can no longer pay its debts when they are due, or in full. Insolvency is otherwise recognised as the point at which a company’s debts outweigh its assets. There are both many internal and external factors which can lead a company into insolvency, from external shifts in market demand to the overreliance on a supplier or b2b customers who have suddenly ceased trading.
How to tell when your company is insolvent?
It is likely that you will be aware that your company is in a state of financial distress. As a director of a limited company, it is important to recognise the point when your company becomes insolvent, as your directors duties change significantly in that your primary duty is owed to all creditors, not just one or specific creditors – instead of shareholders.
There are two main tests which can determine whether your company is insolvent, these are the Cash Flow Test and the Balance Sheet Test.
Cash Flow Test: a company is cash-flow when its ability to meet its outgoings including salaries, payment of suppliers, and other bills on time or in full, in the reasonable near future.
Balance Sheet Test: a company is balance sheet insolvency when the value of a companies assets is less than the amount of its liabilities
What happens when my company becomes insolvent?
When a company is deemed insolvent, it is important that you must take action immediately to ensure that you aren’t minimising further losses to creditors. Commonly this will mean cease trading immediately, however, in certain cases it may be more beneficial to continue trading. In any case it is vital that you approach a licensed insolvency practitioner to discuss the most suitable options available. Failing to do so may mean that you are in breach of your duties as a director of an insolvent limited company, and may open yourself up to personal liability.