What Are The Tests of Insolvency

The Cashflow Test

Simply put, can the company pay its debts when they become due?

For example, if you do not pay the NIC and Income Tax deductions from employees to HMRC on the 19th of the month following the month they were deducted, the company is most likely insolvent.

If your trade creditors sell to you on 30-day terms and you regularly pay on 90-day terms, the company may be insolvent.

A director is legally required to understand this issue. If he or she believes that the company does not have enough cash to pay its liabilities on time, they must seek advice or take action.

So, if your company is not paying creditors on time, has numerous threats, county court summons, or county court judgements, or receives numerous phone calls chasing money, it is most likely insolvent.

The Balance Sheet Test

Simply put, do you owe more than you own as a company, or are the company’s assets greater than its liabilities? If this is the case, the company may be bankrupt. It is important to note that this test should include contingent or prospective liabilities. (If you need advice on these issues email us).

Many directors tell us that because the company does not fail the balance sheet test, they do not need to act. However, based on the cashflow test, the company may still be insolvent. So you must act if it is.

In our experience, an apparently solvent balance sheet may include items that are overstated, such as obsolete stock and work in progress, or debtors who are not really collectible. Many balance sheets become insolvent after removing these items. So be cautious – you are legally required to present accounts that show a true and fair picture of the business.

So, if your company has a negative balance sheet, it IS INSOLVENT.

The Legal Action Test

If a creditor obtains a County Court Judgment, this may demonstrate the company’s insolvency, and the creditor may petition to wind up the company.

If a creditor receives a Statutory Demand for more than £750 and it remains unpaid for more than 21 days, the creditor may petition to wind up the company.

So, if your company has a CCJ or a winding-up petition, it is most likely insolvent.

If you believe that any of the above tests are positive for your company, it is critical that you and the board of directors take action to address the insolvent situation. However, don’t panic; instead, carefully examine all relevant issues and consider the rest of this website.

Remember, if the company is insolvent, you must act in the best interests of the creditors.
If there is no reasonable chance of the following happening:

New or additional capital or finance is introduced into the business to return the balance sheet to a solvent position or to relieve cashflow pressures.

The company’s sale or acquisition.

A company’s voluntary arrangement or administration.

The directors could then be charged with wrongful trading. If you are concerned about this, or if your accountant is, look into directors disqualification.