Written by Jon Munnery, Insolvency & Restructuring Expert, UK Liquidators
Turbulent trading conditions can push the balance sheet of a company into the red and cash flow into disarray, resulting in little in the way of financial fuel. If a business is cash poor, this could hinder both organic and artificial growth as it cuts off access to resources that are essential to keep a business ticking and the lights switched on. Whether a business is experiencing a hiccup or prolonged financial disruption, how close is it to becoming insolvent?
Company insolvency is no frivolous topic, as when you fail to sound the alarm bells early or call in the insolvency brigade as soon as teething problems come to light, you run the risk of losing lifelines that could save the business. Experiencing financial hurdles is like walking on a tightrope – away from optimum business health, and towards financial ruin. If the balancing act is out of sync, the business runs being starved of cash, colliding head-on with creditors, and halting company operations.
What does it mean to be technically insolvent?
If a company is unable to fulfil its liabilities as and when they fall due, this means that it’s cash flow insolvent. A company can also declare balance sheet insolvency which is when company liabilities outweigh company assets. Both of which can be determined by the cash flow and balance sheet test for insolvency, which business owners can carry out with support from their accountant or financial adviser.
The Insolvency Act 1986 defines the inability to pay debts and financial distress as:
· When the company has neglected to pay, secure, or compound a claim for the sum due to the creditor (exceeds £750) within three weeks of receiving a written demand in the form of a statutory demand.
· When the company has failed to satisfy creditors in relation to the debt following enforcement action.
· If it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due.
· A company is deemed unable to pay its debts if the value of the company’s assets is less than the amount of its liabilities, including contingent and prospective liabilities.
A business in financial distress can quickly turn its fortunes around and drastically change its prospects by seeking a professional advisor at the onset of experiencing financial distress.
On the edge of insolvency
While there are universal signs that show whether a business is on the edge of insolvency, here are some additional tell-tale signs and considerations that businesses must make to overcome their decline from a shortfall in cash and/or overwhelming company liabilities.
· Growth screeches to a standstill – Company growth is likely to dwindle if there are limitations on cash earmarked to reinvest in the business. For a company to ambitiously grow, it may depend on specialist lending, although given the circumstances, it may be required to unplug from this support to drive down monthly expenses. Business finance can help a business
maintain its market share and achieve growth targets which can reap rewards for stakeholders and employees alike, so when access to this is withdrawn, company growth may screech to a standstill.
· Investments are cut off– If the business makes regular contributions to investment schemes or replenishes investments when cash is plentiful, this strategy may be revised to retain more cash in the business for a rainy day, or to boost working capital. As such, the business may cut off or temporarily pause investment contributions.
· Creditor pressure is cushioned – One of the first signs that a business is in financial distress is persistent pressure from creditors. From a payment reminder, payment demand, to a final warning, creditor pressure can quickly take the form of legal action. To cushion the business against creditor pressure, the company director may seek restructuring support through a licensed insolvency practitioner.
· Credit lines are reduced – If the business extends credit to customers, it may cut off new applications or scale back credit limits to reduce risk exposure to the business. Stepping up debt recovery efforts will also help a business recover funds owed to them which can boost the cash position of the business.
The cash flow and balance sheet tests for insolvency will determine the severity of the problem and indicate whether the business can be salvaged by a licensed insolvency practitioner. Entering selected formal insolvency procedures can also protect against legal action from creditors and provide breathing space for the business while it regains its footing.
If a business is on a tightrope, tip-toeing closer to the prospect of becoming insolvent, a licensed insolvency practitioner can provide stability and help the business reach a soft landing.
