Businesses face numerous financial challenges in today’s rapidly changing global economy, where nothing is predictable. The Covid-19 pandemic has caused the downfall of the world’s major economies. Due to which several companies have faced insolvency, and some are still fighting to prevent it. So, in this blog, we will see what is insolvency, how to know whether your company is insolvent and how to prevent insolvency?
What is Insolvency?
A company is facing insolvency when it is unable to pay off its debts on time. For businesses, insolvency can be seen as bankruptcy in many aspects. Insolvency is when the liabilities of a company are outweighed then its assets and when the company is no longer able to pay its outgoings on time.
Insolvency is dangerous for a company, but it does not mean that it can not be prevented. There are many business recovery and rescue options available that can help a company to put itself back on the road to financial success.
Key takeaway: Remember that insolvency and bankruptcy are two different things.
How to Know Whether your Company is Insolvent?
In order to determine whether your company is insolvent, you can take the following insolvency tests.
1) Cash Flow Test
With the help of a cash flow test, you will be able to check your company’s ability to pay its debts when due for payment. The cash flow test answers the question of whether your company can pay off its bills in full and on time? In case the answer is no, then it’s clear that your company is not solvent.
2) Balance Sheet Test
The balance sheet test looks at all the things that are owned by a company (assets) such as stock, machinery, ledger book, property, and weighs these against the current debts of a company. In case the debts are greater than assets, then the company is facing insolvency.
Signs to Check Whether your Company is Insolvent or not?
The above-mentioned tests can check whether your company is solvent or insolvent, but the following are few other warning signs that should be looked out for as well.
- The company is unable to pay its debts comfortably and making incomplete or late payments to HM Revenue & Customs and/or creditors on a regular basis.
- A creditor has previously issued a statutory payment demand or acquired a CCJ (County Court Judgment) against your company.
- To pay for the basic operating costs, a company lacks the necessary cash flow.
- You are being chased out by HM Revenue & Customs, your bank, mortgagor, lenders, or credit card companies for the amount you owed.
- Your company has borrowed the maximum amount of money (allowed) from the suppliers and/or the bank.
- If the directors are not compensated because of insufficient funds.
What Can You Do to Prevent Insolvency?
It is rightly said that prevention is a preferable treatment. Therefore, you should think about the pre-requisites to prevent going insolvent. You can save yourself from insolvency by:
- Creating a budget
- Maintaining a log of your finances
- Getting a detailed knowledge of your market
Now that you have understood what is insolvency, what causes it, and how to know your company is insolvent. As mentioned above that insolvency is dangerous for a company. Therefore, you must find out the right solutions to it. If your company is heading towards insolvency then the best practice for preventing insolvency is to consult with the licensed insolvency practitioners as soon as possible. Because the sooner you consult them, the better it will be.
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Disclaimer: This blog provides general information on what is insolvency.