Is my Company Insolvent
“Is my company insolvent?” is an important question because it dictates which restructuring solutions are open to a director and also dictates what legal responsibilities a director has to other stakeholders such as creditors and employees.
Most importantly, if the company is insolvent, a director can be personally liable for debts incurred after the date of insolvency due to Insolvent trading and other legal provisions. So directors need to be aware of the company’s financial position and know whether it has crossed the line from “Financial Distress” to “Insolvent”.
Insolvency can be difficult to establish at any given point in time. We have provided below a checklist of matters a director should consider. The Corporations Act tells us that the overriding question a director must answer is:
Is the company able to pay all of its debts as and when they become due and payable?
Usually the answer to this question is not easy! So we don’t want you to answer the question now. First review the list of “Indicators of Insolvency” below.
Indicators of Insolvency
|Comment and explanation
|Tick if applicable
|Cash Flow IndicatorsFactors that indicate the availability of cash, or lack of it, become important. Insolvency must be distinguished from a short term cash-flow problem.
|An inability to raise equity or loan capital.
|A company with insufficient cash to pay its due debts will have to raise extra money to stay solvent. It can do so by way of refinancing, the raising of equity or the rescheduling of debts. An inability to do this within a reasonable time indicates that the problem is not simply short term cash-flow problems.
|Issuing post-dated cheques or having cheques dishonored.
|Issuing a postdated check is an admission that a company has insufficient funds to pay all due debts. A postdated check that is also dishonored is a clear sign that the problem is more than a cash-flow difficulty.
|Payments in rounded sums and for the minimum amount.
|Debtors sometimes resort to making a small payment to a creditor, often in a round amount. This is a sign that the debtor hopes to resolve the situation in the near future and that the creditor will be satisfied with a series of small payments. The inference is that this small payment is being made because the debtor cannot pay all its debts as they fall due.
|Overdue tax remittances.
|Insolvent companies regard withholding the payment of tax commitments as the easiest way of preserving essential cash in the short term. The inference is that any underpaid amount due to the tax office is not paid because the business does not have the capacity to make the payment.
|Financial Statement IndicatorsFinancial statements should provide sufficient information for a company owner to determine the likelihood of insolvency. A lack of financial information does not necessarily indicate insolvency but is a common symptom.
|Continuing losses and insufficient working capital.
|Making continuing losses is a red flag that should alert a director to the possibility of insolvency. Insolvency is brought about by a combination of losses and insufficient working capital to carry the company through to a profitable period.
|A lack of timely and accurate financial information.
|Without regular financial information, a director will not know the financial position of a company. Whilst this does not necessarily dictate that a company is insolvent, it is a very common symptom of an insolvent company.
|Creditor Relationship IndicatorsA company’s solvency often on the support of other stakeholders such as creditors, employees and the bank. An indication of the financial health of a company is the state of the relationship with other key stakeholders.
|Poor relationship with your bank.
|Banks have a privileged position with their ability to see a company’s financial transactions. The bank is often the company’s main source of new funding and if that avenue is closed a company will have limited options.
|Suppliers demanding COD trading or payments before supply.
|Having your company placed on “C.O.D. Only” by a supplier indicates that the supplier has no faith in your company’s ability to pay its debts. A company that has a range of creditors with accounts outside of agreed terms is at high risk of being insolvent.
|Creditors issuing demands or legal proceedings.
|A single demand from a creditor is not proof of insolvency as the debt may be in dispute. However, a series of demands from a number of solicitors will create a strong presumption of insolvency.
|YOUR NUMBER OF TICKS:
We would have liked to now provide you with a simple formula based on the number of ticks you gave to the above indicators of insolvency. Unfortunately, it is not that simple. Here’s what we can say:
- One or two indicators – does not necessarily indicate insolvency, but you should be concerned if the indicators persist.
- Two or three indicators – you should strongly consider the possibility that your company is insolvent.
- Four or more indicators – If your company displays four or more of the above characteristics then your company is probably insolvent.
If you are concerned that your company is insolvent you must act. Review our page on Directors Personal Liability if you need some extra impetus to focus your mind. Remember, that if your company is insolvent you must act to consider other stakeholders such as creditors and employees.
If it is all getting a little confusing then contact one of our advisors.