Accounting insolvency doesn’t necessarily mean your company is bankrupt, as you may still be able to make payments. But it is a serious situation and one about which you should take prompt professional advice.
Accounting Insolvency: Definition
Accounting insolvency – also called technical insolvency – means that the company has a negative net asset value and its liabilities exceed those of its assets – figures for this are assessed purely through examination of the balance sheet.
How is Accounting Insolvency Different from Cashflow Insolvency
The financial health of a company should be regularly assessed by the use of both accounting and cashflow insolvency tests. Cashflow insolvency is when a company cannot meet demands for payments, such as being unable to keep up with borrowing commitments or pay suppliers’ invoices. Cashflow insolvency is often an immediate situation but it may be possible to improve liquidity and continue trading. However, accounting insolvency is when the business is likely to be more permanent and creditors may demand information on what the firm’s plans are and if a restructuring will occur or on whether closure is an option
What are my Company’s Options if Technically Insolvent?
Much depends on the circumstances and what the reasons are for the insolvency – so, has the business over extended itself, has there been a costly lawsuit or fine or is the future trading picture more positive? Business recovery and turnaround strategies tend to be most effective if intervention comes early and directors seek advice before action such as winding up order is taken.
Can a Technically Insolvent Business Continue to Trade?
The company can continue to trade, providing the directors believe they will be able to clear debts and become solvent. It is a fine line, however, if directors are knowingly trading when they believe that closure is likely, then this could impact on creditors receiving payment. Those running the business could also be later be accused of wrongful trading.
If creditors remain unpaid, then problems will become entrenched and any debt over £750 that remains unpaid could be the catalyst for a winding up order.
How Should Directors Deal With Accounting Insolvency?
One answer may be to dispose of assets to cover liabilities, such as stock or property. But, directors should be aware that assets on the balance sheet may have a higher value than can actually be realised. The business could also be impacted by a property slump or if there is oversupply of the goods being sold, for example. Selling off assets to solve a cashflow crisis may also trigger accounting insolvency.
However, it should be remembered that borrowing more is not always going to help – loans mean interest and increasing the size of the debt could worsen the situation longer term.
Other measures could include negotiating better terms with suppliers so that they accept later payments and improving debt collection measures. However, if arrears with VAT or National Insurance have built up, the company may find there is limited room to negotiate, particularly if they leave this late in the day. Other ways to make savings could mean reducing headcounts and pulling out of unprofitable lines of business.