What are the warning signs of an insolvent company?

Insolvency signsThere are several warning signs that a company may be insolvent, which include an inability to pay bills on time, increased borrowing, and shrinking margins. If a company is frequently late in paying its suppliers, this is a red flag that it is having cash flow problems.

Similarly, if a company is taking out more loans or issuing more debt, this may be a sign that it is struggling to stay afloat. Finally, if a company’s profit margins are shrinking, this could indicate that it is no longer able to generate enough revenue to cover its costs.

If a company is exhibiting any of these warning signs, it may be headed for insolvency. We explore the key warning signs of impending business failure, and what you can do about them.

A business enters the state of insolvency when it is unable to repay money owed and fulfil financial liabilities. Burying your head in the sand isn’t an option.

If these warning signs of failing business are ringing true to you, it’s time for decisive action. If there is any chance that your business is going to have any chance of surviving what’s to come.

The common warning signs of insolvency are:

An insolvent company is one that’s in danger of closing down. Classic tests and common warning signs for insolvency are:

  • Being unable to meet financial obligations as they fall due
  • Where the total value of company assets is less than money owed
  • Overtrading (lack of capital to pursue growth strategy, declining profit margins)
  • Accrued debts with HM Revenue & Customs
  • Significant bad debts & ageing debtor ledger
  • Terminal bank overdraft position – continually at the limit
  • Bank withdraws overdraft
  • High staff turnover
  • Delays in producing and providing financial information when requested
  • CCJ’s, Statutory Demands or WRITS registered against the Company
  • Loss of major contacts resulting in cash flow crisis
  • Constantly receiving red-top letters from creditors
  • Bailiffs attending to pursue unpaid debts

However, by recognising the early signs of insolvency and seeking advice, a company has a chance to turn things around.

Although not an exhaustive list, here are some classic signs of insolvency.

Important warning signs of limited company insolvency

One of the most important things for limited company directors to be aware of is the early warning signs of insolvency. By recognising these indicators and taking action quickly, it may be possible to avoid the company becoming insolvent.

Some of the key warning signs to look out for include:

Maximum borrowing

If you have reached the limit of your bank overdraft and have been refused further borrowing, you may be in danger of bouncing company cheques. This will cause more problems with suppliers who may decide to take legal action in the form of a statutory demand. To avoid this, you will need to either find another source of credit or provide personal guarantees to your lender.

You have no reliable management information

Businesses large or small, it is vital that there are systems in place to provide reliable management information such as cash flow forecasts. This information is essential in order to make informed decisions about the performance of the business and to plan for the future. Without this information, it is impossible to say with any certainty how much money is owed, what the extent of the company’s debt is, or what sales are likely to be. This can put the company in a very precarious position, as rescue options are severely limited. In order to avoid this situation, it is essential that businesses have systems in place to provide accurate and up-to-date information about their performance.

Demands for payment

Demands for payment, whether from HMRC or other creditors, are a serious issue for any company. If you are facing demands for payment, it is important to take action immediately in order to protect your business. A Statutory Demand is often closely followed by a winding up petition, which could effectively mark the end for your business should the courts order that the company is liquidated.

If HMRC are chasing you for payment, the company is already in the danger zone as they are relentless in the pursuit of bad debts. Penalties for late payment of tax can be significant, making a dire financial situation untenable. Other warning signs in relation to creditors include taking an increasingly longer period of time to pay trade creditors and dealing with complaints by creditors on a daily basis.

Creditor warning signs include:

• Taking a longer time to pay trade creditors
• Firefighting issues on a daily basis when dealing with creditors
• Stock deliveries are delayed as a result production/sales start to falling behind

No money to pay staff wages

No business owner ever wants to face the reality that their company is insolvent, but it is important to be aware of the signs so that you can take action as early as possible. One of the most common indicators of insolvency is a lack of money to pay staff wages. This is often a result of falling behind on invoices and not having enough cash coming in to cover all of the expenses. If you find yourself in this situation, it is important to act quickly.

Speak with your employees and explain the situation. You may need to make some difficult decisions, such as laying off staff or cutting salaries, but it is better to do this than to let the company collapse completely. There are other signs of insolvency, such as consistently making late payments or only being able to make minimum payments on debts, but a lack of money to pay wages is one of the most common indicators that a company is in trouble.

Company insolvency tests

Company insolvency is determined by two main tests: the balance sheet insolvency test and the cash flow test. The balance sheet test looks at whether a company has enough assets to cover its liabilities. If the answer is no, then the company is insolvent. The cash flow test, on the other hand, assesses whether a company has the ability to pay its bills as they come due.

If it cannot, then it is also considered insolvent. In most cases, a company will be considered insolvent if it fails either of these tests. However, it is important to note that these are just general guidelines; insolvency can also be determined by other factors, such as business performance or the opinion of creditors.

Cash flow test

The purpose of the cash flow test is to ensure that businesses are able to pay their debts as they fall due, without dipping into their reserves. This includes not only current debts, but also those which will fall due in the reasonably near future. The term ‘reasonably near future’ depends on the industry in which you operate and the nature of your business.

For example, if your creditors impose 30-day terms for payment and you regularly fail to adhere to these terms, paying only after 90 days, it is likely that you are trading insolvently. Cash flow forecasting can help you to stay on top of your finances and avoid insolvency.

A strong indicators of company insolvency are:

  • The failure to pay or set aside a 21-day Statutory Demand of more than £750. 
  • The failure to adhere to the terms of a court order or pay a judgment in full.

Balance sheet test

The balance sheet test is used to determine the likelihood of the value of your assets being less than your liabilities. To carry out this test with any accuracy, you will need to appoint an independent expert to value company assets correctly, and take into account all contingent liabilities.

If liabilities were to exceed assets, you would be unable to repay creditors as there would be insufficient funds even if you sold all the company’s assets. Therefore, it can be said that your company is on the verge of insolvency if the figures for liabilities and assets are comparable. Balance sheet testing is therefore an essential tool for any business owner looking to ensure the financial health of their company.

Read more: My business is not making sales

What to do if your company is insolvent

A company is insolvent if it is unable to pay its debts as and when they fall due. If you find yourself in this situation, you have a legal obligation to put the interests of your creditors ahead of your own. This may mean ceasing trading immediately in order to prevent the accrual of further debt, which would reduce the value of the company. A licensed insolvency practitioner will be able to advise you on whether stopping trade is the best course of action, or if continuing to trade is likely to increase the return to creditors.

While a finding of insolvency may seem like the end for your business, it is important to remember that there are a number of formal insolvency options available which could turn things around. With the right advice and support, your company could make a successful recovery.

It’s important that directors seek professional advice if they recognise any warning signs of insolvency, the are a number of options open to limited company, to discuss yours, contact us on the number above or simply complete the online enquiry form.

Steve Jones Profile
Insolvency & Restructuring Expert at Business Insolvency Helpline

With over three decades of experience in the business and turnaround sector, Steve Jones is one of the founders of Business Insolvency Helpline. With specialist knowledge of Insolvency, Liquidations, Administration, Pre-packs, CVA, MVL, Restructuring Advice and Company investment.