What are the warning signs of insolvency? It’s important to know them because directors who continue to trade while insolvent risk fines, being made personally responsible for company debts, or even a potential disqualification from directorship, as a result.
One aspect of insolvency that surprises so many company directors is just how quickly it can sneak up on you. You’ll be aware that you are experiencing some problems paying your debts, but there is a definite line between being in debt and being insolvent. This is a position that, as a company director, you must keep a careful eye on. As soon as the company becomes insolvent, you must act to maximise the creditors’ interests.
Our advice is to get in touch with a turnaround practitioner at your earliest opportunity if the following warning signs are true for your limited company.
Is Your Limited Company Insolvent? Take the Insolvency Test
Insolvency is not an instant or immediate state. It can take weeks, months or even years for a faltering business to become insolvent The two basic methods of assessing whether your company is insolvent are as follows:
(1) Balance Sheet Test for Insolvency
Are your companies liabilities greater than your assets?
(2) Cash Flow Test for Insolvency
Do you owe more money at any given time than you can pay? An accurate balance sheet calculation should include contingent as well as prospective liabilities.
We have created an easy to use insolvency test calculator here.
Some people consider the following a third part of the test:
(3) The Legal Action Test for Insolvency
If you have received a statutory demand or a County Court Judgement, you should know these are precedents a creditor could use to follow up with a Winding up Petition, a final payment demand after which your company could be forcibly liquidated. Any legal action may be taken as a strong warning signal.
What are the Warning Signs for Insolvency?
- Insufficient cashflow – If your company consistently lacks the funds to cover essential operating expenses it’s simply a matter of time before it becomes insolvent.
- Overdraft Limit – If your company is also functioning at the limit of your overdraft this is a clear indication of cash flow problems.
- Creditor pressure – Are you under pressure from creditors? A payment demand could be just around the corner if lenders, credit card companies, HMRC, mortgage providers or other creditors regularly chase you for payments. If payment is still not forthcoming, a winding up petition could be the next step.
- Wage commitments – A business’ inability to pay its employees is a common indicator of looming insolvency.
- Secured finance – Be aware if you are factoring and or have a secured loan you are vulnerable to having the bank take control of your business and put in a receiver to secure their assets.
- Constantly Dealing with Problems – If you are spending most of your time ‘fire fighting’ and preventing problems from escalating, rather than focusing on the day-to-day activities of your business, you need to take a serious look at the overall health of your business. Simply going from one problem to the next is a strong indicator that your business is struggling.
Litigation Threats and Creditor Pressure are Strong Insolvency Warning Signs
Already mentioned but worth reiterating is that, the threat of litigation is a huge indicator that insolvency could be on the horizon. If you’ve received a County Court Judgement, Statutory Demand or Winding up Petition, this means you have creditors who are extremely anxious to get what is owed them and are now using the legal system to do so. That legal system is designed to escalate the situation to a point where those creditors can be paid, or you will have to close your limited company.
Banking and insolvency risks
There is no such thing as a friendly bank and I’m afraid a lot of the horror stories you hear or read are probably true. We have had to try and rescue solid business where the bank has simply decided for its own reasons to withdraw lending without notice. These cases are as shocking as they are often unnecessary as quite often the director sleepwalked into insolvency by allowing the banks to control the company cash-flow. Often increased charges and fees come out of the blue and you have no say in the matter. If you are small company factoring is unlikely to help your situation and is likely to make matters worse – there are alternatives to factoring.
And never, ever have your company banking and factoring with the same banking group as you are handing complete control across to a faceless individual who only has the bank’s interests at heart – not yours.
If you’re Insolvent, Seek Advice Immediately to Avoid Potential Charges of Wrongful Trading
If the following are true of your business, the likelihood is your business is already insolvent and you should cease trading and inform your creditors immediately:
- You struggle to maintain your financial obligations and regularly make late payments to creditors and HMRC.
- A County Court Judgement (CCJ) or statutory payment order has been made against your business.
- The company’s liabilities are equal to or greater than the market value of the company’s assets, inclusive of equipment, buildings, money in the bank and debtors.
- The directors or other company employees are not receiving a wage.
If the underlying issues of the insolvency are not addressed, at best your business is heading for liquidation and eventual dissolution; at worst, you could be accused of misconduct and disqualified from acting as a director of any UK company for a maximum of 15 years.
The good news is if you are a director and you are approaching insolvency or you think your company is insolvent but unsure you do get acknowledgement that you sought professional advice. If you seek assistance at the first sign of trouble, a viable business may be able to trade its way out of trouble while repaying creditors over an agreed term.
There are a wide range of potential business rescue options at your disposal to meet the specifics of your situation. Please get in touch for your free consultation.