A Directors Guide to Insolvency: How to recognise it

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Article by Laura Walshe of The Business Debt Advisor

There have been several high-profile insolvencies within the last year.

Formal insolvency processes such as Administration and Liquidation appear to be becoming increasingly prevalent, affecting businesses that are familiar to us all.

But how do company directors recognise if their business is insolvent?

Recognising Insolvency

The nature of their role means that directors are likely to be busy with the day-to-day management of the business.

However, it is important they maintain and review information which enables them to make an informed view of business performance as a whole, rather than to make decisions based on isolated incidents.

Directors should rely on accurate information and management accounts to assess whether there is any cause for concern. Management accounts are likely to include details of turnover, profit (or loss) and future projections.

It is worthwhile investing time in establishing procedures and reports so that any decisions made can be done so with confidence.

Some of the most common warning signs are:

1. Demands for Payment

Most businesses will receive a demand for payment at one time or another. However, if this is not simply an oversight then this could be one of the first signs of difficulty ahead.

Making payments on an erratic basis will also have a negative impact on cash flow, and you may feel that you are simply ‘fire fighting’.

2. Debt owing to HMRC

Receiving a letter from HMRC can be a daunting experience.

These letters are intended to encourage payment and under no circumstance should tax debts be ignored.

If you engage with HMRC this will demonstrate a desire to deal with the company’s tax affairs, and it could even be possible to agree a time-to-pay plan.

3. Legal Action

If the position is serious, your business may be under significant pressure from creditors and key suppliers.

You could even find it impossible to appease such creditors, which could result in enforcement action or even a winding-up petition.

4. Over Indebtedness

Many businesses operate an overdraft facility or other credit facilities, which is perfectly acceptable.

However, these credit facilities should be relied upon for temporary assistance only. Consistently operating at credit limits is unsustainable and might indicate there is a more serious issue.

The Tests

The Insolvency Act sets out that a company is insolvent if it cannot pay its bills as they fall due, or if its total liabilities exceed the value of assets.

The following tests can help to determine if either (or both) of these are applicable.

The ‘Cash Flow’ Test

Where expenditure routinely exceeds income, this is an indication the business is actually spending more than it can afford.

Where cash flow is strained it will be stressful and ultimately have an effect on operational performance.

The ‘Balance Sheet’ Test

Where total debts (including any future debts) exceed the value of a company’s assets, the company is deemed to be insolvent.

When taking account of the company’s position it is important to give an accurate indication as to the realisable value of assets, not necessarily the value stated within the last set of accounts.


If you consider that your business could be in financial distress you should speak to an Insolvency Practitioner at the earliest opportunity.

With proper advice you will be able to take back control and decide on the next steps, whether this involves restructuring or taking action wind up.

If you would like additional advice please fill out our Contact Formand we will be in touch with you. Alternatively, call us on 0800 781 0990.  Our team has extensive experience and can arrange an initial consultation at no cost, usually on the same day.

The Business Debt Advisor is a trading division of The Debt Advisor Ltd which is authorised and regulated by The Financial Conduct Authority number 659920. Beverley Budsworth is the MD and is also an Insolvency Practitioner regulated by The Insolvency Practitioners Association.

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