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What are the warning signs of company insolvency?

27 Mar 2024

A limited company is deemed to be insolvent when it meets one of the following two criteria:

  • It is unable to service its debts and ongoing costs as and when they fall due – this is known as cash flow insolvency.
  • Its liabilities exceed its assets – this is known as balance sheet insolvency.

When a company is knowingly insolvent, its directors have a number of legal duties and responsibilities which they must ensure they comply with. One of these is to prioritise the interests of creditors, placing these above the interests of the company’s directors and shareholders. In many cases this may mean that trade has to cease immediately in order to shield creditors from further losses and ensure their position is not worsened. Due to this, it is imperative that directors are aware of the signs of impending insolvency so that they can take swift action to control the problems being faced before the situation escalates.

While insolvency can manifest itself in a number of ways, there are some common warning signs to be aware of which could signal all is not well with the financial and/or operational health of the company:

  • Squeezed cash flow – Maintaining a healthy cash flow is at the heart of any successful business. Once cash flow becomes compromised, problems can quickly begin to mount so this should be seen as a huge warning sign that the financial position of the company is unsustainable unless changes are made to improve the situation. When assessing cash flow, you must consider both the incomings and outgoings of the company. Ensure you have a robust debt collection strategy that chases up late payers and minimises the risk of incurring bad debt. Investigate your outgoings and monthly commitments and consider whether any cost-reduction measures can be implemented to help boost your cash flow.
  • Late payments to creditors – Being unable to pay your creditors as and when they fall due indicates your company could be on the way to finding itself in an insolvent position. You may find some creditors pile on the pressure to recover the money they owe which could see you inadvertently prioritising paying some creditors to the detriment of others. If this happens when you know your company is insolvent, this could be seen as a breach of your duties. If you have found yourself in the position where you are choosing which creditors to pay because you are unable to fully meet your obligations, you should take this as a sign that you need to seek professional advice from an insolvency professional.
  • Unable to access credit – Perhaps you have maxed out your overdraft, your applications for business loans or credit cards have been rejected, or maybe your creditors are refusing to extend any further borrowing until you clear the outstanding invoices. If any of these sound familiar, you may be at greater risk of insolvency. When creditors and finance companies begin to restrict your borrowing levels, this is often because they have assessed your company as riskier than they would like. By limiting the amount you can borrow, they are protecting themselves from incurring further losses in the event that your company enters into a formal insolvency procedure such as liquidation.
  • Threats of legal action – Depending on how much you owe, who you owe this money to, and how long you have been in arrears with them, you may find creditors lose their patience with you and have to resort to legal action in an attempt to recover the money you owe. Creditor threats to begin winding up proceedings against your company should be taken extremely seriously. HMRC initiate more winding up proceedings than any other creditor, so if you have fallen behind in your tax obligations and are unable or unwilling to enter into negotiations to arrange payment of the money owed, you could find yourself threatened with a winding up petition. This could end up with your company being forced into compulsory liquidation if the court believes your company to be insolvent.
  • Unable to pay staff on time – Ensuring staff are paid in full and on time should be a top priority for any business owner. Once you lose the confidence of your employees, operations can grind to a halt if staff decide to down tools until their wages are paid up to date. As most directors will prioritise employee salaries as far as they can, the company not having sufficient funds to allow for this should sound alarm bells for the overall financial health of the business.

If you believe your company may be on the verge of insolvency – or perhaps is already insolvent – you should seek the advice of a licensed insolvency practitioner as a matter of urgency. An insolvency practitioner will be able to help you better understand the position your company is in, as well as explain the possible options for rescue, recovery, or closure.