Expert advice on the business of running a garment decoration company
Is my company insolvent?
One of the most difficult and important questions for a director to answer honestly is whether their company is insolvent. For a director of a family-run company there is the additional burden of pride – the company may have been handed down through the generations and nobody wants to be in charge when insolvency looms.
Once a director forms the view that the company is insolvent there is a duty to act primarily in the interest of the company’s creditors. A director who allows a company to continue to trade and incur liabilities at a time when they know or ought to have known that there was no reasonable prospect of the company avoiding an insolvent liquidation (or an insolvent administration) may incur personal liability for the losses sustained by the company’s creditors in an action against them known as wrongful trading.
There are three simple key indicators that allow you to identify whether your company is insolvent.
1. Cash flow test The first test is: Can my company pay its debts as they fall due? An inability to pay suppliers on time, and often requesting longer credit periods, may well be a sign that the business is insolvent. Likewise, while your business may not be cash flow insolvent, one of your debtors may well be. It is important to recognise that a request for a longer credit period or a debtor not paying on time is an indication that they may have financial issues that ultimately impact on your business.
2. Balance sheet test This second test considers whether a company’s assets exceed its liabilities. In the event they do not, a director should seek advice as to whether they should continue to trade. They need to ensure that they minimise the risk to creditors with a view to ensure that unlawful trading does not occur.
3. Litigation test Thirdly, company directors need to consider the litigation test. While the level of debt required to present a bankruptcy petition against an individual has been increased to £5,000, a creditor that is owed more than £750 by a company can serve a formal written demand in respect of that unpaid debt. It is usual for that demand to be in the form of a statutory demand and a director whose company has been served with a statutory demand or formal written demand has a period of twenty-one days in which to settle the debt or could be faced with a creditor petitioning to wind up the company. Likewise a director who is constantly receiving threats of litigation against the company ought to consider in detail the solvency of the company and then apply the cash flow test and balance sheet test referred to above.
If a director believes that their company is approaching insolvency, they should realise that the situation does not necessarily mean that it is the end of the road for the business. There are options available to rescue companies – the earlier a director intervenes to rescue a company with the assistance of a specialist insolvency solicitor and/or insolvency practitioner, the more options there are open to that company and the better the chance of avoiding liquidation.