One particularly crucial question that a business may need to ask themselves during the most challenging periods, may be “Is my company making money?” At the end of the day, if the company isn’t making money, then it’s failing, and this could lead to a case of insolvency.

While determining whether your company is making money can be as easy as checking your end-year management accounts and reviewing your bank accounts, the question of solvency can be a little more complicated to answer.

Insolvency, from a professional standpoint, happens when an organization is no longer to meet the financial obligations that have been set in place between it, and its lenders, or lender.

Insolvency can lead to insolvency proceedings, in which creditors may take legal action against the insolvent entity in an effort to use some of the remaining assets of the company to pay off mounting debts. Insolvency can arise for a number of reasons, from poor cash management, to differences in forecasted cash flow, or simply sheer bad luck.

But how can you tell for sure if your business is insolvent, or whether it’s heading in that direction?

On the surface, many companies believe that business insolvency is a straight-forward condition to diagnose. However, the truth is that many businesses which appear to be secure, are actually insolvent.

While every financial situation is different, in general, there are three primary methods that can be used to identify business insolvency. These methods relate to the balance sheet of the company, the available cash flow, and the presence of any legal action.

Balance Sheet – Does the Business Owe more than it Owns

The first key test for insolvency starts with your balance sheet. If the assets generated by a company are greater than the liabilities contained within, then that business is solvent.

On the other hand, if the liabilities of a business outweigh the assets, it will be deemed insolvent. Take a look at the assets that you have available to you at this time, and try to add them up to at least a basic estimation of your overall business worth.

After that, make a list of all the debts and payments that you’re expected to make to creditors in order to keep your business running.

If the two lists don’t balance, and you end up in a position wherein you’re paying out more money than you’re bringing in, this could be a sign of impending insolvency. After all, a business cannot be successful when the costs of running operations are higher than the profits obtained from those operations.

Cash Flow – Can the Business Pay Debts when They’re Due?

Your cash flow will be unique to your business, so it’s important to remember that even if you look at example cash flow sheets online, they may not be able to offer you an insight into what your balances should look like. Examine the numbers of your cash flow carefully, and think about the terms of your suppliers.

For instance, if you have supplier terms with a limit of thirty days, does your cash flow suggest that you will be able to make payment in that time, or do you often have to ask for extensions? At the same time, think about your employees, and whether you’re able to pay their Tax deductions ant National Insurance to HM Revenue & Customs by the 19th of each month.

If your VAT and PAYE is quickly adding up, and you’re unable to pay your debts when they’re owed, your business could be suffering from insolvency.

Typically, the cash flow test is seen as the more stringent test for insolvency, and it’s also where a number of struggling small companies have been having difficulties over the recent years.

Legal Action – Are Creditors taking the Business to Court?

The legal action test asks whether your company creditor has been able to bring legal action against your company successfully as a result of unpaid debt.

This would mean that either one or more of your company creditors have taken out a “CCJ” (County Court Judgement) or statutory demand against your company.

If a creditor has made the decision to obtain judgement against the business in a court of law, and the court states that the business should pay the creditor money which remains unpaid, the court may need to examine your finances and designate your business as insolvent.

If this does happen, then the creditor may attempt to recover at least a portion of the money that they are owed through bailiffs, or they may send a petition to the court to begin with bankruptcy proceedings.

Any creditor owed more than £750 by any business can petition the court to order that company into liquidation if the debt cannot be settled within a period of 21 days.

Other Indicators of Impending Insolvency

While the three tests above are often the main indicators of insolvency, there are other signs that could emerge that may require you to rethink your company finances, and the solvency of your business.

For example, if you’ve been avoiding paying your taxes, such as PAYG, or GST on time so that you can pay creditors that are vital to your business, this could be a sign that you are headed for insolvency, as most businesses should be able to pay for their tax liabilities close to the due date.

Other potential warning signs may include:

  • Constant losses – while every company makes losses during the life cycle of its trading experience, those losses are not necessarily a sign that the company is insolvent. However, when the losses in question cannot be covered by the working capital of the business, this could be a sign that insolvency is on the horizon.
  • Liquidity – Is your company liquidity ratio under 1? In other words, do the liquid assets available to the company cover any debts? If they don’t this can be another sign of insolvency, but it can also simply be a sign of bad times for a company.
  • Bank relationship problems – If the bank your company works with refuses your funds, decreases your overdraft, or dishonours your company cheques, then this could be an indicator that you are approaching insolvency.
  • Can you raise capital? – If you are unable to raise the necessary finance involved with paying your company’s debts when they fall due, either by borrowing funds or raising funds in the form of equity investments, this could be a sign of insolvency.
  • COD Arrangements – If your supplier places you on a “Cash on Delivery” or COD arrangement, or demands payments before resuming supply, this could be a clear indication that the supplier has no faith in your company’s solvency.
  • Post-dated Cheques – If you have been issuing post-dated checks to creditors for a significant period of time, the chances are that your company is becoming insolvent.

What Should You Do If Your Company is Insolvent?

If this article has left you feeling concerned about the solvency of your company, then the best thing you can do is to seek immediate professional advice from an Insolvency Practice such as Robson Scott.

We will be able to give you further advice on what you may need to do next. Remember that it’s not enough to simply sit back and hope for the best when insolvency is a factor. If you believe that your business solvency is failing, it is your responsibility to act as quickly as possible.

As a director, your interests will shift away from simply looking after your business, to considering what is best for your creditors.

If you weren’t aware of the level of responsibility that falls on your shoulders as a result of insolvency, you are not alone. Most directors have no idea what their legal obligations are in regards to creditors as a result of business insolvency, unless they have had previous experience in the situation.

Yet, the consequences of misconduct in regards to business insolvency can lead to a director being held personally liable for business debts, and even imprisonment.

If, like many companies, you’re new to the idea of business insolvency, it’s generally a good idea to speak to a professional and obtain the correct guidance to navigate the process.

An expert should be able to give you the facts about your obligations and duties as a director, while advising you about whether, in your circumstances, you have a viable chance of business turnaround.