What are the warning signs of company insolvency?

A limited company can be said to be technically insolvent when it is unable to repay money owed and fulfil financial obligations such as bills and contractual monthly repayments as and when they fall due. A company can also be said to be insolvent if its liabilities (debts) outweigh its assets (the things it owns).

When directors are caught up in the day-to-day running of their company, it is very easy to miss the signs of approaching insolvency. It is perhaps easier to attribute cash flow problems to a temporary blip in your company's finances rather than consider the fact that this could hint at deeper rooted problems. However, the sooner you accept the problems you are facing, the sooner a plan can be put in place to get your business back on a solid financial footing.

There are a number of signs you should be on the lookout for if you believe your company could be approaching - or may already be - insolvent. If you are experiencing one or more of the problems described below, you may need to seek guidance on company insolvency procedures from a licensed insolvency practitioner in order to avoid further complications.

Maximum borrowing

You have reached the limit of your bank overdraft and have been refused further borrowing without providing personal guarantees. Suppliers are refusing you credit, and you do not own sufficient assets to obtain a secured short-term loan. If company cheques have bounced, this will cause more problems with suppliers who may decide to take legal action in the form of a statutory demand.

Demands for payment

You may have received a Statutory Demand from a secured or unsecured creditor, or are constantly receiving threats of legal action against the company for unpaid bills. A Statutory Demand is often closely followed by a winding up petition, which could effectively mark the end for your business should the courts order that the company is liquidated.

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 untenable. As of 1 January 2023, HMRC have introduced penalties for late VAT return submissions. 

Other warning signs in relation to creditors include:

• Taking an increasingly longer period of time to pay trade creditors
• Dealing with complaints by creditors, and ‘firefighting’ issues on a daily basis
• Deliveries of stock are delayed and production/sales are falling behind as a result.

No money to pay staff wages

If the likelihood of meeting the wage bill is slim, this is a sure sign that insolvency is looming. You may not have taken a salary from the business yourself for a few months in the hope that the next big sale will correct the situation, but it is very rarely the case, and once employee’s wages go unpaid your company is already technically insolvent.

These are a few of the major warning signs of insolvency, but there are also specific tests that can be carried out to confirm a company's solvency (or insolvency).

Company insolvency tests

A company is said to be insolvent if it cannot pay its bills as they fall due, or the total of its liabilities exceeds the total value of assets.

There are two tests to determine if either or both of the above are true:

Cash flow test

Being able to pay debts as they presently fall due, as well as those which fall due in the ‘reasonably near future’ is the general test for cash flow. The term ‘reasonably near future’ depends in part on the industry in which you operate, and the nature of your business.

If your creditors impose 30-day terms for payment and you regularly fail to adhere to these terms, paying only after 90 days for example, it is likely that you are trading insolvently.

This is often the first sign of potential problems, which is why regular monitoring of the company’s financial position is so important. Other strong indications of insolvency are:

• Failing to meet a 21-day Statutory Demand for payment of more than £750. 
• Failing to adhere to the terms of a court order or judgment.

If you are found to be insolvent but still trading, as a director you would face allegations of unlawful trading, and may become personally liable for some or all of the company’s debts.

Balance sheet test

This tests the likelihood of the value of your assets being less than your liabilities. To determine this with any accuracy you will need to appoint an independent expert to value company assets correctly, and take into account all contingent liabilities.

Should liabilities exceed assets, you would be unable to repay creditors as there would be insufficient funds even if you sold all the company’s assets. Therefore, it can be said that your company is on the verge of insolvency if the figures for liabilities and assets are comparable.

Even if this test appears to indicate that the company is solvent, the cash flow test could return a less hopeful result. That is why it is important to view the results as a whole, as well as independently.

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 cease 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.

Begbies Traynor is the UK’s market leader in corporate recovery. We operate from offices spanning numerous UK locations and offer same day consultations free of charge.