Cash Flow or Balance Sheet Insolvent
What does it mean?
When a company is falling behind with payments due to suppliers, HMRC, financiers or staff – with no clear opportunity to get back on track – then the company is likely to be insolvent. Evidence of this might be a tightening of cash flow, chasing letters from creditors, court enforcement or bailiff action.
There are two tests that can be applied to assess an organisation’s financial viability: the cash flow test and the balance sheet test.
Q. What is the cash flow test?
A. The cash flow test checks whether the company can meet its obligations, i.e. whether it can pay its debts as and when they fall due.
Q. What is the balance sheet test?
A. The balance sheet test reviews the assets and liabilities of an organisation. If the asset value is less than outstanding liabilities, the organisation is considered insolvent, i.e. it doesn’t have the means to meet either its current liability problem or liabilities likely to be incurred in the future as part of continued trading.
Q. Why are both tests applied?
A. If the cash flow test is applied by itself, any creditors who supplied goods and services AFTER the company reached the point of no return would lose out because of the deficit in its assets versus liabilities.
Q. What is the next step if the tests show that a company is or may be insolvent?
A. The directors should seek prompt professional advice from a Licensed Insolvency Practitioner to clarify their situation and determine an appropriate course of action; this might involve rescuing the company as a going concern or closing it down.
Q. How long should an insolvent company trade for?
A. Directors have a duty to minimise losses to the company creditors, therefore they shouldn’t continue to trade unless they have strong reasons to believe that the company will return to profitability and be able to repay creditors. This is to protect them from being disqualified from acting as company directors in future or becoming liable for the debts of the company.
If you would like any more information about cash flow/balance sheet tests, or if you are at all concerned about insolvency, please do not hesitate to contact us. We will gladly hold a free, no obligation meeting to discuss all your options.