What’s the cash flow test for company insolvency? Richard talks us through
- How the cash flow test can show if you have cash flow issues
- Why this means you’re insolvent
- When to seek help for insolvency
- Solving insolvency through cash flow forecasting
- Why a cash flow forecast is so important
Hello, Richard Simms from FA Simms and Partners. We’re here today as part of our series of podcasts. And today we’re talking about how do I know if a business is insolvent?
What we’re looking at in particular today is the first of the two principle tests for insolvency, which is what’s known as the cash flow test. Now it’s actually quite a logical test, this one, because what it says is basically: if I can’t pay as a business owner, as a business, I can’t pay those who I owe money to on time, then technically arguably the company’s insolvent.
Why is that important? Because that date, when you first can’t pay creditors on time, you can’t pay those you owe money to on time, is the point by which if the company was to end up in some sort of formal insolvency process, that’s the date that backtracks the investigation.
Because if something was to go wrong with a company, it did end up in the formal insolvency process, there’s a window of time when you say “actually when was the business first insolvent?” And that’s the point of time when the directors and the owners of the business should have taken steps to consider the position the business is facing.
If you go on from that situation of realising the company is technically insolvent, because you’re not paying those you need to pay on time, then you’re potentially digging the hole deeper. You’re getting further and further in debt and there is a potential risk for you. Then as a business owner or company owner, by continuing after the point of insolvency has been identified then in fact the blame falls with yourself or the company director. The creditors end up worse off for your actions after that point in time.
So really important you recognise the situation as a director. Really important you recognise that the company is potentially becoming insolvent and take the necessary steps to help yourself. So how will you know then? What will happen?
I mentioned in the previous podcast that perhaps a lot of businesses in the UK will generally run that creditors quite long if they can. They won’t pay people necessarily bang on time. They’ll try not to pay people on time if they can help, that’s very much the approach.
I have to confess, we try to pay our creditors on time from our end. We don’t necessarily pay them early but we actually pay them within the time we should pay. That’s one of the things we try to do as a business, that’s a personal view. A lot of people don’t choose to do that. A lot of people let them run as long as they can. But be careful to make sure where you are deciding between a choice and the pressure point where you don’t have the opportunity to change it.
What we’re looking for here, to a large extent, is saying, “well look, I’m managing my creditors. I’m not on top of paying who I owe money to.” We then say, when does that information become public? What does it get to a situation where there’s a record, some evidence to support that that position has arrived.
Let’s say you have a letter from a creditor saying, “I’m going to take you to court. If you don’t pay me in seven days I’m going to start legal action.” HMRC’s saying they’re going to present you with a winding up petition. Any sort of action that becomes public because it’s in the public domain. So for example, courts issue a County Court Judgement or you’re threatened with a winding up petition. Anything that becomes public, of course, is very difficult for you to argue against because it is there for that reason.
So we’ve got some stages before that, which is where you’re going to say, “well, I’m starting to get some red letters or starting to get some threatening indications from my creditors, they’re starting to put me under a bit of pressure.” That’s again where you can see arguably that, potentially technically that, actually the position of insolvency is starting at that point forward.
That’s a concern because if you can’t respond to that, if you don’t respond to that point, that’s where you’re going to find yourself in trouble as a company director. It’s massively important that you see that and deal with it.
Okay. Well, how do you do that? How do you help yourself do that?
Most companies and businesses will work with an external accountant, somebody works to help them with this. And what we’re looking at here is having yourself some form of cash flow forecasting in the business. Massively important for a business. And really, if you imagine you don’t have a cash flow forecast, you’re driving your car down a country road at night with no lights on. How can you see what you’re doing? How do you see where you’re going?
Now, some businesses we work with will do a daily cash flow. Literally they will change their cash flow forecast every day, to forecast for the next couple of weeks, couple of months. So they know what’s coming in, when it’s going out. If money doesn’t come in, it means they can’t pay out, et cetera, et cetera.
It’s up to you to decide how close you want to manage your cash flow. But to me, strong cash flow management is massively important to a business. And it’s not an option. It’s not a choice. That’s what you do ‘cause you fancy. It is really important to you. As an area where if you’re not sure how to work on that, how to start on that, have a chat with your accountant. Let them help you set that up. Get a structure in place for you.
A client I dealt with years and years and years ago. Went out to see them. He had an in-house accountant who worked with him, very nice person and worked very closely with them. And the director brought it to me and said, “Here Richard, here’s our cash flow forecast.” And I looked at it and said, “Sorry, but it makes no sense. I don’t understand it. It doesn’t make any sense to me.” The director said to me, “No, I don’t understand that either.” I said, “Well, politely, what use is it to you?”
So I sat there for half an hour and we changed the format around a bit. We moved the order of things around a bit. And that point forward, he was very open. He said, “Now I can manage my cash flow, I’m not responding to it.”
So the risk is if you’re just solely responding to the fact that payment doesn’t come in, you can’t make the payment a day later. How much more pressure are you putting yourself under as a business owner? Much more pressure than you should do. So again, look at your cash flow forecast, help yourself there.
There’s been a slight deviation at that point, but just try and work out how you can best help yourself. Okay? How can you do that? Really make sure you can follow your cash flow. Don’t let it control you. Manage it, make it your control. Adjust your business as you need to.
If you don’t and you end up in a situation where you do find you’re not paying creditors on time, the red letters start arriving. The pressure points start coming forward. You don’t see a way of easily resolving that situation. So you know that you’ve got some pressure coming back. You maybe can’t see a big order coming in when you need it. That’s the time to get some help. That’s time to have a conversation, protect yourself as a business owner and company director, by getting the right advice. To make sure you consider the situation. To get the help you need. Get yourself forward from debt. Okay.
That’s the end of this particular podcast, we’re going to talk about in a separate podcast, the balance sheets insolvency tests, which is a second test for insolvency. Hope you can join us for that. Thank you.