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If you know your business is struggling financially, there’s a chance you might be insolvent – and even trading against the law. There are two types of tests that you can carry out to determine the financial health of your business. A cash flow test assesses whether you are able to pay your liabilities as and when they fall due, whereas a balance sheet test assesses whether a company’s total liabilities (such as loans, accounts payable, mortgages) are greater than its assets.
So you could technically be insolvent according to a cash flow test if, for instance, you are a new company receiving investment. Although in this case you may not have enough cash to help pay your bills, you are still able to via investment funds. Crucially, if it’s deemed you would be able to pay your bills ‘in the reasonably near future’ then you could be in the clear for a cash flow test – but that doesn’t guarantee that you are entirely out of the woods just yet.
That is why it’s important to also carry out a balance sheet test. Below we explain why in more detail.
Reality Check
When you have an inkling things aren’t as rosy as you’d like, it’s easy to bury your head in the sand and try to avoid looking too closely. However, knowing your financial status is extremely important, especially if you are the director of the business. If the test reveals you are insolvent, it’s time to act now – but even if you haven’t quite reached that point it should help you get to grips with the course of action needed to improve your position and to see whether you can get your business back on track.
Seek Professional Help
Carrying out a balance sheet test will help you decide whether you need to turn to the experts for further advice and support. If your business is deemed insolvent, then you should hire a licensed insolvency practitioner like who can support you through the next steps. Similarly, if you want to be sure your balance sheet test is accurate, it’s worth spending a bit of money employing someone with experience who can help you through it. It’s important the test gives a true representation of the state of the business as pleading ignorance isn’t classed as a defense to charges such as wrongful trading, which we come onto in more detail below.
Stay On The Right Side Of The Law
Perhaps the main reason businesses should carry out a balance sheet test is to avoid possible action later down the line. According to Insolvency Practitioners Hudson Weir, “trading while facing insolvency could see the director of the company charged with wrongful trading and made personally responsible for the company’s liabilities, as well as being disqualified from becoming a director again in the future.” It is the responsibility of a director to understand their company’s financial position and there’s no way of getting round it by claiming you didn’t know how bad things were.
Assess Your Company’s Future
Whatever the outcome of your balance sheet test, it should leave you with a better idea of what steps to take next – even if it reveals your business is insolvent. For example, if you feel your financial difficulties are only temporary and there is no immediate threat of action from creditors, you could contact them to try and reach an informal agreement. Doing this early can be a big advantage and often makes a deal much more likely. Other options include entering a company voluntary arrangement (CVA) or going into administration, which enables the business to continue without any legal action from creditors being taken.
If you’re feeling worried about your company’s finances then a balance sheet test should be at the top of your ‘to do’ list, especially if you want to keep all possible options open.
