An unexpected downturn in the market can easily have severe implications on business. This is true, even if your company’s financial situation has never been a cause for concern.

It’s important to know if a business is in trouble because directors who continue to trade while the business is insolvent risk being made personally responsible for company debts, or even a potential disqualification from directorship.

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.

Here are few indicators or early warning signs that could lead to insolvency, which a company director should monitor regularly.

Company cash flow problems

Company cash flow problems aren’t necessarily an indication of company insolvency, but it’s always something to be mindful of. Many factors can cause cash flow problems, such as poor sales and a lack of credit control. However, it’s important to understand exactly what is causing problems, and manage your cash flow on a regular basis.

Borrowing

You have reached the limit of your bank overdraft and have been refused further borrowing without providing personal guarantees. If suppliers refuse you credit, you could be facing the early signs of insolvency. If your company regularly has to borrow money to pay creditors and staff wages etc., this is referred to as ‘ceiling borrowing’, and often suggests a company may be on the brink of insolvency.

Winding up petition

If your creditors feel that you are no longer able to pay your company debts, they can apply to the courts for a winding up petition for compulsory liquidation. The creditors only need to be owed more than £750 to submit the petition to the courts. This is typically expensive for creditors to do, and they do this as a last resort. Prior to the winding up petition, it’s likely that your company will have been served a statutory demand, with 21 days to make your repayments or dispute the demand. It is imperative to take a statutory demand seriously and devise a corrective course of action.

If HMRC are chasing you for payment, the company is already in the danger zone as they are relentless in the pursuit of bad debts. Penalties for late payment of tax can be significant, making a dire financial situation unsustainable.

Late payments

If you are struggling to keep up with late payments, this could be a sign of deep-rooted problems for your company. Those late payments can also affect your company’s credit score, which could have long-lasting consequences. Late payments suggest you are not operating within your limits and will alert the bank to look into your company’s financial situation.

Directors are not paid

Another sign of company insolvency is a director pay freeze. If a director’s wages are affected and, effectively, stopped – even for the good of the company assets – this conveys serious problems.

Other signs of insolvency

There are several other reasons as to why a business may fall into company insolvency, and we have outlined some of the most common:

• Overtrading with a lack of funds and profit margin
• Delays in providing financial information
• Loss of major contracts
• Profit decline in particular industry
• CCJ’s against the company
• Deliveries of stock are delayed and production/sales are falling behind as a result
• No money to pay staff wages

Company Insolvency Tests

If you are worried about insolvency, there are two tests to determine whether your company is deemed to be insolvent; cash flow and balance sheet. It’s important to remember a business is regarded as insolvent, due to the Insolvency Act 1986, if they cannot pay their debts as they fall.

Cash Flow Test

The ability to pay your company debts as they fall due, or in the ‘near future,’ is generally the test for cash flow solvency. If you cannot pay your debts within the amount of time provided, exceeding payment dates, then you could be deemed insolvent.

Balance Sheet Test

The balance sheet test is designed to ascertain whether your company assets are less than your liabilities. You will need to appoint someone who is independent of the company to do this. If those liabilities exceed your assets, then your company is on the verge of insolvency – even if you sold the company assets.

What to do if your company is insolvent?

If you find that your company is insolvent you have an obligation to put the interests of creditors ahead of your own in these circumstances. This may mean that you need to stop trading immediately in order to ensure your company does not accrue further debt, and therefore reduce the value in the company.

A licensed insolvency practitioner will be able to determine whether the business needs to stop trading, or whether trade can continue if this is likely to increase the return to creditors.

A verdict of insolvency does not necessarily mean the end for your business, however. It is encouraging to note that a variety of formal insolvency options could turn your company around.

These include a Company Voluntary Arrangement, which may be suitable if creditors are threatening legal action, and Company Administration, whereby an administrator is appointed with a view to restructuring the company and returning it to profitability.

If you need help understanding the best way forward for your company, use our live chat during working hours, or call us on 0131 297 7899. We’ve helped 1000’s of directors navigate difficult financial circumstances.