IS MY COMPANY INSOLVENT?

If your company is experiencing cash flow difficulties e.g. paying suppliers late, falling behind with HMRC, and chased customers for payment, perhaps you should ask whether these issues are manageable or an indication of serious underlying financial problems.

A key step is to establish whether your company can meet its liabilities as and when they fall due in the normal course of business. If the answer to this question is “no”, your company may be insolvent and is one of the definitions of apparent insolvency in section 123 of the Insolvency Act 1986.

Some early signs may be in evidence e.g.

1. Are there cash-flow problems e.g. difficulty paying employees and/or suppliers?
2. Is forced cost-cutting necessary in order to pay bills?
3. Are you seeking to extend payment terms with suppliers : all of them or just the main ones?
4. Is the overdraft increasing without an obvious plan to reduce it?
5. Are you looking for additional funding from external sources?
6. Do you need to provide some of your own money to keep cash flow under control?
7. Are lucrative contracts ending without appropriate replacements?
8. Is your industry experiencing a general downturn?
9. Are there political or environmental effects which are detrimental to the business conditions?

Once early signs become a feature of normal operating activities a director may face more specific issues that can cause concern e.g.

1. Can’t pay VAT, PAYE, NIC or corporation tax
2. Loss of turnover
3. Submitting accounts late
4. Factoring seen as a short-term solution
5. Signing personal guarantees
6. Avoiding telephone calls and letters
7. Feeling stressed at work and home
8. Inability to pay staff
9. Rent arrears
10. Bad debts
11. Overtrading i.e. operating at a level which current cash resources cannot support

It is a director’s legal duty to consider the interests of all stakeholder groups e.g. employees, customers, suppliers, HMRC, directors and shareholders. A significant benefit of limited company status is the general protection of directors from personal liability, but this protective bubble can be burst when the company becomes insolvent and continues to trade.

The balance sheet test

Ask yourself, does the company owe more than it owns e.g. are the company’s assets exceeded by its liabilities? If yes, then the company could be insolvent.

It is important to point out that this test should include both contingent and prospective liabilities e.g. where a court has yet to make a decision on how much the company owes as a result of a creditor action, or dilapidations on a building that the business is due to vacate. Further, when conducting a financial assessment, a director should ensure that the balance sheet does not include assets that are overstated, such as obsolete stock, work in progress that will never be billed, or debtors that are not recoverable. After deducting these items a balance sheet may become insolvent.

In summary, the balance sheet should show a realistic picture of the business rather than one that a director would prefer to exist.
The legal action test

If a creditor has obtained a court decree, this may demonstrate the company’s insolvency and could mean that the creditor will petition to liquidate the company. There are various technicalities to observe but in general terms, a director should consider matters very seriously if a court decree has been awarded against the company.

What now?

If any of the tests indicate that the company is insolvent, care is needed to address the position sooner rather than later. Consider the issues and who can be approached for advice because frequently, a small company with only one or two directors, may find it difficult to know who to approach and what to ask.

Prompt and decisive action should be taken by the company in order to determine whether a restructuring strategy might breathe life into all or part of the company, or whether the business is no longer viable and needs to be liquidated. An appointment with a licensed insolvency practitioner “IP” is an obvious step, the first visit normally being at no charge to the director. An independent assessment should prove the way to considering the options and deciding how to proceed.

Having consulted with an IP, a director will probably be faced with a number of options. Depending on the severity of the situation and how promptly advice has been sought, the options may be limited.

The earlier that a company’s financial problems are identified/confronted, the greater the chance of arresting the decline and affecting a positive turnaround. However, all too often a director will bury his head in the sand hoping that creditor pressure will subside, which is not the action of a responsible person.

Turnaround options

Seeking early advice can offer potential turnaround options. An IP will be able to establish whether a company could benefit from restructuring and rescue procedures such as a company voluntary arrangement “CVA”, administration or refinancing.

CVA is an increasingly common procedure that ring-fences an insolvent company from creditors in order to provide breathing space to try to resolve issues whilst repaying all, or some, liabilities over affordable monthly payments.

Administration is a formal insolvency procedure which is used quite frequently and can halt any action being taken against a company when it is in financial difficulties but the director can see a viable way forward. The process stops a creditor presenting a liquidation petition to court or otherwise taking steps to thwart a restructuring process.

Liquidation

When a company is insolvent but perhaps capable of being saved, in whole or in part, attempting to arrest its decline and introducing measures to improve the company’s fortunes is a key objective for the IP. However, if careful review concludes that such an option is not achievable and closure is inevitable, a liquidation process is likely to be the course or action. Virtually every liquidation is a death knell, resulting in job losses and corporate collapse.