How to tell if your company is insolvent and what to do

By Carl Faulds

Facing up to the fact that your business is insolvent isn’t easy. However, to stand any chance of saving the company, it’s crucial to be able to recognise the warning signs. The technical definition of insolvency is when a business can no longer meet its financial obligations, whether to its suppliers or its lenders. However, insolvency is usually a destination rather than a straightforward event, and there are normally signs that serious financial problems are looming. Here’s how to recognise them.

Do you owe more than you own?

If the assets on your balance sheet exceed the liabilities, then you are solvent. If the situation is reversed, then you are clearly insolvent. To make this evaluation, it’s important that you value your assets realistically and include all liabilities, including payments that will shortly become due, in the calculation.

Can you pay your debts?

The second thing to consider is your cash flow. Even growing, profitable businesses can hit sudden cash flow crises – in fact, a period of rapid growth is the most dangerous time, since you will need to invest in raw materials, people and equipment before your new customers pay you. If you’re often having to ask your suppliers to vary their terms of business to give you extra time to pay, that’s a clear sign your cash flow is in trouble. Similarly, if you can’t pay your VAT or corporation tax on time, you will incur some severe penalties and may even find yourself wound up.

Are you unable to borrow?

A deteriorating relationship with your bank or business finance provider can make it difficult to borrow in order to smooth over a cash flow crisis. Once no provider – bank, alternative lender, peer-to-peer lender – will do business with you, then borrowing becomes impossible and even a small cash flow problem will be able to trip you up into possible insolvency.

Are your creditors pressing you for payment?

If your suppliers have rescinded your credit terms and started demanding cash payments – or, worse, begun suing you to recover debts – then you’re almost certainly insolvent. Once court judgments are made and you fail to comply, your finances will come under legal scrutiny and the decision whether to consider trading could be taken out of your hands.

Are you consistently making losses?

Not every company will make profits every year, particularly when it’s necessary to reinvest in the business to power growth. But if you’re making losses year on year, the company may not have a future and you will urgently need to look at cutting costs to start generating some profit and avoid becoming insolvent.

What happens if you find you’re insolvent?

A lot of people think that insolvency means bankruptcy and the end of the business, but that doesn’t have to be the case. Take out a Company Voluntary Arrangement (CVA) and a specialist insolvency practitioner will be able to negotiate a settlement with your creditors whilst you are protected from legal action. This usually involves your creditors agreeing to accept some proportion of their debts – and more importantly involves you staying in control of your company, rather than an administrator or liquidator being appointed.

In simple terms, a CVA gives you time to get your business back on its feet and back into profit. But whilst insolvency needn’t mean the end, it’s important to recognise the warning signs so you can avoid it altogether.

Carl Faulds is managing director at Cashsolv