Insolvency is often a direct result of financial instability, poor cash-flow and mounting debts. Although cash flow is a principal factor for evaluating a company’s insolvency, there are many other elements which can contribute to your poor financial condition.
Business insolvency is certainly the last term you would want to hear. This happens when you are unable to pay the bills or loan instalments on time due to a plethora of reasons. Inability to meet your expenses does not necessarily mean that your business is at the verge of insolvency. However, if you doubt that your company is sufficiently solvent, then follow the steps given below to identify if your company is moving towards insolvency.
Take Insolvency Tests
Start by taking an insolvency test. The UK Supreme Court has described the details of an insolvency test which can be used to determine if a company is insolvent. These are set out in section 123(2) of the Insolvency Act of 1986. A company needs to pass two types of insolvency tests, including cash-flow test and balance sheet test.
- If the company fails to pay its debts, it fails in the cash-flow test.
- If the value of the company’s assets is less than the amount of its liabilities, it fails the balance sheet test.
If the court has to decide insolvency, it will consider both tests and compare them to reach a decision. However, if the court has to consider more than the reasonably near future, it discards the cash-flow test and considers the balance-sheet test only.
Get Professional Assistance
Getting assistance from corporate recovery professionals and insolvency experts can help you determine the problematic elements of your business, and evaluate if your company is insolvent or not. You can also seek consultation and guidance regarding techniques to prevent insolvency and for improving your business processes. You don’t have to commit to a professional straight away. Instead, take a good look at their website and see what guidance they provide first. One good example to consider if your business is in the UK is www.companyrescue.co.uk who I found through the free guide they offer for ‘worried directors’. The better you understand the situation you’re in, the easier the process will be.
When choosing insolvency experts, it is important to ask the following questions.
- What is your area of expertise?
- How long have you been practising advisory services?
- Have you worked in financial advisory or related fields before?
- Will you provide guidance about the possible options of recovering from financial instability and preventing insolvency in the future?
For most small businesses, cash-flow is the biggest challenge which can lead to insolvency. Various factors affect your business’ cash inflow and outflow. It is necessary to manage these factors beforehand to avoid any kind of financial vulnerability.
You need to take care of the following factors:
- Prompt invoicing
- Debt recoveries and punctual payment of instalments
- Controlled trading – avoid overtrading at all costs
- Negotiate credit limits – renegotiate when needed
- Avoid approaching the bank or creditors
- Minimise expenses
- Get cash-flow assistance from a professional financial service providers
Negotiate with Your Creditors
It is important to be in communication with your creditors and manage their expectations as otherwise you will find yourself “firefighting” and not able to concentrate on the business.
Look for Company Voluntary Arrangements
A Company Voluntary Arrangements can grant you extra time to pay off your debts or write part of the debt off with consent of the creditors. It is a legal agreement of suspending payments, and is signed by you (the business) and the creditors. Make sure to include a ‘freeze interest’ clause in your CVA to ensure that the interest does not multiply over time before you can start paying the debts off. Alternatively if the company is likely to make more money then a higher can be given to the creditors.
Improve Finance Information Systems
Do you keep up to date balance sheets? Are all invoices updated and entered in the records? Do you make debt and bill payments and enter them in your records?
You can prevent late invoices or delayed payments and pay the creditors on time if all your financial information systems are regularised and updated.
Minimise Further Borrowing
If you believe that your company is at the verge of insolvency, it is necessary to stop borrowing any further, unless there is no other option available. After that, try reducing the existing debts that have piled up.
Prioritise Expenses and Minimise Cash Outflow
Prepare a list of necessary expenses and cut down your costs by minimising cash outflow. Some businesses downsize their human resources to cut costs. You can use the money to negotiate with creditors and minimise the debts. Make sure to keep trading under strict control, especially if you trying to minimise cash outflow.