Insolvency Test Meaning
The insolvency test refers to three simple checks to determine the insolvency status of a business, or individual. In this case, we have focused on the insolvency status of a business.
The three checks that the insolvency test covers are as follows:
- The cash-flow test.
- The balance sheet test.
- The legal action test.
Cash-flow Insolvency Test
The cash-flow test is designed to find out whether a business can pay its bills when they fall due.
This test isn’t simply about can you pay your bills at this exact moment, either. The legal requirement is that you are able to pay your bills in the ‘in the reasonably near future.’
What Qualifies as Insolvency? – If your business cannot pay its bills on time, the chances are that it is mostly likely insolvent.
Balance Sheet Insolvency Test
This part of the test aims to determine whether the value of the business’ cash at the bank, as well as the total value of assets combined, are more or less in value than the total value of liabilities that the business has.
The balance sheet test is one you will ideally look at in conjunction with your accountant as these figures must be accurately and clearly represented.
The biggest risk for directors in insolvency is the accusation of wrongful trading which means you placed any interest ahead of creditors once you became aware of your financial position. This means you can’t pay yourself, any stuff, or even one supplier over another. Your responsibility is to the group of creditors as a whole and you need to be able to demonstrate that.
So work through the balance sheet test carefully and, ensure you’re working with an accountant you trust.
What qualifies as insolvency? – If the total value of assets and cash combined has a value that is less than the total value of liabilities under the business name, chances are, it is insolvent.
The Legal Action Insolvency Test
The final part of the test aims to highlight whether any legal action has been taken out against the business for any debt to the value of £750 or more.
This refers specifically to Statutory Demands, or County Court Judgements, both of which are the classic precedents to a winding up procedure.
What qualifies as insolvency? – If your business has had legal action set against it of this value of debt or greater, your business may be insolvent.
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