Is my company insolvent?

Even thinking about insolvency is enough to make most company directors anxious and stressed. However, if you think your company is insolvent, then as a director you must equip yourself with the facts about the company’s financial status. You then need to start acting in the creditors’ interests, not the company’s.

Asking an Insolvency Practitioner (IP) to give expert advice covers these responsibilities, whereas if you ignore these issues when you should have been aware of them, you could become personally liable for money owed by the company.

Many directors don’t actually know how to tell whether their company is insolvent, so let’s look at the key signs. There are two tests which will help you and any third party decide whether your company is insolvent: the cashflow solvency test and the balance sheet solvency test.

The cashflow solvency test

This is the simpler test to apply because the questions are straightforward:

Can you pay your suppliers on time?

If you have suppliers who supply you on the basis that you’ll pay them 30 days later, but you frequently pay them 60 or 90 days later, this could be a sign that your company is insolvent i.e. it cannot pay its creditors as bills fall due.

Are you paying PAYE and NICs on time?

If you have employees, or draw a salary yourself, you have to pay HMRC the National Insurance Contributions for both employee and employer, and the tax you have collected (PAYE). Three years ago HMRC brought in Real Time Information for PAYE. This requires that if your company employs someone, including yourself, you have to tell HMRC how much PAYE you owe, immediately the company pays the employee.

Most payroll packages used by accountants and small firms will automatically send the information to the government gateway. (There are some different arrangements for very small employers). So HMRC is well aware of how much you owe, and if you keep missing or underpaying, you are in default and this could well be a sign that the company is insolvent.

Can you pay VAT and Corporation Tax?

HMRC takes a dim view of companies that collect VAT and fail to pass it on when due. It means that you have spent the VAT to provide working capital for your company. You will be surcharged and will then enter a period where you will get further penalties for being in any arrears. If you’re unable to pay these taxes as they fall due, it’s a good bet that your company is insolvent.

County court judgements and statutory demands

If a creditor has been to the county court and obtained a judgement against the company for non-payment of a debt, this may be taken as a symptom of insolvency, unless the non-payment was part of a trade dispute.

If the debt is more than £5,000, the creditor may serve you with a “statutory demand”. This is very simple for the creditor to take out, but don’t ignore it on the grounds it didn’t involve a court. If you don’t respond, the creditor might take out a winding-up petition. A company cannot challenge a statutory demand itself, but it can challenge any winding-up petition that results.

The balance sheet solvency test

Some directors are not good at balance sheet calculations, preferring to leave this area to the accountant, but in this case it’s a simple question of whether your company owns more than it owes. Does the company have more assets than liabilities? Has it got more goods, stock, cash due from debtors and money than it owes to its creditors?

An accurate balance sheet depends on everything being included that should be and both assets and liabilities being correctly valued. Otherwise your balance sheet may tell you that the company is solvent when in fact it isn’t.

Does the company have “Contingent Liabilities”?

The idea that the balance sheet tells you whether a company is solvent or not has a long legal history. The Supreme Court ruled in 2013 that for a company to be deemed insolvent, the court needs to be satisfied that the company won’t have enough assets to meet its liabilities when they fall due. The court said that this definition included “contingent liabilities”.

So what are these? And why do you need to make sure your balance sheet takes account of them?
When one of your creditors asks a court to rule in their favour and order repayment of a debt, the process can take some time and you may also dispute it. However, this is probably a debt coming down the road towards the company sometime in the future, if the court rules in favour of the creditor. This is a liability for the company and in this context it’s called a “contingent liability”. It’s a potential loss that may occur in the future.

You can’t ignore this possibility when you or your accountant draw up the balance sheet and decide whether the company is solvent or not. One of the options you may be considering is using Members’ Voluntary Liquidation (MVL) of the company, to close it down in a controlled way. This route is only available if the company is solvent.

However, once contingent liabilities are taken into account, you may find that the company is not, as you thought, solvent, it is in fact insolvent. The MVL is therefore no longer an option and must be changed to a Creditors’ Voluntary Liquidation (CVL). This will be a nasty surprise for the members and shareholders because they won’t get the cash that is left over after liquidation which they would expect in an MVL. That cash goes to the creditors in a CVL.

And since you may have formally declared your company to be solvent, in the process of setting up the MVL, you could now be in a difficult position. Yet another reason to get professional advice from an experienced IP who is well aware of these traps and will help you to avoid them.

Valuing assets correctly

Manipulating the balance sheet can make a company appear that it is solvent when in fact it isn’t. You may not even realise that your balance sheet is misleading, yet if you use it to prove solvency that doesn’t exist, you are putting yourself in a perilous position.

One of the commonest ways in which balance sheets can be misleading, is that they incorrectly value the company’s assets, placing too high a valuation on them. This can occur for all sorts of reasons.

For example, you may have stock in the warehouse that is no longer worth as much as it was, for a variety of reasons. Or the depreciation being booked on cars and vans is not realistic. Here again, changes in the business climate or property values can affect the balance sheet. Even the mighty Tesco had to write down the value of its property assets when it realised that out of town mega stores were going out of fashion, and it held a large amount of land that was now less likely to be developed and was therefore less valuable.

Some businesses use the value of stock to adjust their tax liabilities from one year to another. A company with a lot of money tied up in stock may pay less corporation tax. A company with a small amount of money tied up in stock can look like a better financial prospect when it tries to borrow. However, in the situation of a possible insolvency, stock needs to be valued in a realistic way so that if you are challenged you can show that you have kept accurate books.

What do I do now?

If the company is insolvent under either the cash flow or balance sheet test, then it must be counted as insolvent. You need to protect yourself and any other directors from a charge of wrongful trading which could be brought against you if you continue to trade when you know, or ought to know, that the company is insolvent. The only exceptions are:

  • You have a firm prospect of fresh capital being injected into the business
  • You expect to sell the company
  • You expect to make a company voluntary arrangement (CVA) or set up an administration arrangement.

If none of these apply, you will need to contact an Insolvency Practitioner as soon as possible. The longer you delay, the more your options will be constrained.

You also need to make sure that all of your company’s records and documentation are up to date and in order. This is in case the IP or an Administrator wants to inspect it, to ensure that you have run the company in a responsible manner and that you have been following the rules.

There are many ways forward after insolvency, so it doesn’t have to be the end of the road. Some of the arrangements, such as the CVA mentioned above, can turn an insolvent company back into a solvent one. However, it’s important to face facts, so taking a hard look at the company’s finances and finding out whether it’s insolvent is a positive first step.