IS MY BUSINESS INSOLVENT ?
The answer to the question “Is my company insolvent?” is important because it dictates which restructuring solutions are open to a director and also dictates what legal responsibilities a director has to other stakeholders such as creditors and employees. Most importantly, if the company is insolvent, a director can be personally liable for debts incurred after the date of insolvency due to Insolvent trading and other legal provisions. So directors need to be aware of the company's financial position and know whether it has crossed the line from "Financial Distress" to "Insolvent"
Is the company able to pay all of its debts as and when they become due and payable?
Usually the answer to this question is not easy! So we don't want you to answer the question now. First review the list of "Indicators of Insolvency" below.
Cash Flow Indicators
Factors that indicate the availability of cash, or lack of it, become imvportant. Insolvency must be distinguished from a short term cash-flow problem.
An inability to raise equity or loan capital.
Issuing a postdated check is an admission that a company has insufficient funds to pay all due debts. A postdated check that is also dishonored is a clear sign that the problem is more than a cash-flow difficulty.
Payments in rounded sums and for the minimum amount.
Debtors sometimes resort to making a small payment to a creditor, often in a round amount. This is a sign that the debtor hopes to resolve the situation in the near future and that the creditor will be satisfied with a series of small payments. The inference is that this small payment is being made because the debtor cannot pay all its debts as they fall due.
Overdue tax returns
Insolvent companies regard withholding the payment of tax commitments as the easiest way of preserving essential cash in the short term. The inference is that any underpaid amount due to the tax office is not paid because the business does not have the capacity to make the payment.
Financial Statement Indicators
Financial statements should provide sufficient information for a company owner to determine the likelihood of insolvency. A lack of financial information does not necessarily indicate insolvency but is a common symptom.
Continuing losses and insufficient working capital
Making continuing losses is a red flag that should alert a director to the possibility of insolvency. Insolvency is brought about by a combination of losses and insufficient working capital to carry the company through to a profitable period.
A lack of timely and accurate financial information.
Without regular financial information, a director will not know the financial position of a company. Whilst this does not necessarily dictate that a company is insolvent, it is a very common symptom of an insolvent company
Creditor Relationship Indicators
A company's solvency often on the support of other stakeholders such as creditors, employees and the bank. An indication of the financial health of a company is the state of the relationship with other key stakeholders
Poor relationship with your bank.
Banks have a privileged position with their ability to see a company's financial transactions. The bank is often the company's main source of new funding and if that avenue is closed a company will have limited options
Suppliers demanding COD trading or payments before supply
Having your company placed on "C.O.D. Only" by a supplier indicates that the supplier has no faith in your company's ability to pay its debts. A company that has a range of creditors with accounts outside of agreed terms is at high risk of being insolvent.
Creditors issuing demands or legal proceedings
A single demand from a creditor is not proof of insolvency as the debt may be in dispute. However, a series of demands from a number of solicitors will create a strong presumption of insolvency.
1 OR 2 INDICATORS: - does not necessarily indicate insolvency, but you should be concerned if the indicators persist
2 OR 3 INDICATORS: - you should strongly consider the possibility that your company is insolvent
4 OR MORE INDICATORS: - If your company displays four or more of the above characteristics then your company is probably insolvent.
If you are concerned that your company is insolvent you must act NOW.
A company with insufficient cash to pay its due debts will have to raise extra money to stay solvent. It can do so by way of refinancing, the raising of equity or the rescheduling of debts. An inability to do this within a reasonable time indicates that the problem is not simply short term cash-flow problems