How to Spot the Warning Signs of an Insolvent Company

October 18, 2023 / Business Insolvency

How can a director spot the warning signs that their company is insolvent?

Ernest Hemingway wrote in his novel, The Sun Also Rises:

“How did you go bankrupt?” Bill asked. 

“Two ways,” Mike said. “Gradually and then suddenly.” 

It can be like that for a company facing insolvency, which is the corporate equivalent of going bankrupt.

In this article, Clarke Bell will provide an overview of insolvency, its main causes, and what you can do if your company is facing financial difficulties.

What does insolvency mean for a company?

In essence, insolvency is the situation where a company that have fewer assets than debts – i.e. it is unable to repay its debts. Sometimes it can be reversed, but it many cases it means the end of the company.

The warning signs of an insolvent company

To prevent your company from falling into insolvency, you’ll need to spot the signs beforehand. In doing so, you’ll give yourself much more time to act, and increase the odds of achieving a favourable outcome. While there are several signs that indicate impending insolvency, we will focus on the mains ones:

Creditors demand repayment

Slipping into insolvency can be difficult to notice while in the thick of it. A responsible director will be busy working to stabilise their struggling company, and it can be easy to miss otherwise clear red flags. That said, receiving demands from creditors for loan repayments, repayments your company cannot make, is a sign of potential insolvency.

Creditor demands for repayment are simultaneously the clearest and most alarming sign of insolvency problems. This is especially true if one of your demanding creditors is HMRC, as they are quick to take action against insolvent companies. If you are slow to react to these demands, you risk having your company served with a winding-up petition and placed into compulsory liquidation.

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Difficulty in paying operational costs

Another indicator is difficulty in paying operational costs. Companies that struggle to purchase new stock, pay staff, and cover other vital costs are certainly in financial distress. While potentially not as threatening as direct demands from creditors, struggling to pay operational costs needs swift action.

Reaching borrowing limits

If your company has reached its borrowing limits, or been refused further credit, then insolvency could well be around the corner. This can manifest in several ways, from simply having applications for new loans be declined or reaching the limit on business credit cards.

Cash flow test results

Another warning sign of an insolvent company comes in the form of a cash flow test. In essence, this test uses loans due in the near future as a benchmark. It considers three main factors, whether you can:

  1. pay a statutory demand within its 21-day time frame
  2. make a loan repayment if it were due within a given time frame, and 
  3. comply with a court order. 

If your company couldn’t meet all three of these criteria, then your company would be considered insolvent. 

Continuing trading as an insolvent company can result in far-reaching implications, making swift action paramount.

Your options if your company is insolvent

If your company is insolvent, you have pro-active options at your disposal. 

The right one will depend on the specifics of your situation, and what you’d like as an outcome. Whichever you choose, remember that it’s vital to act swiftly once you know your company is insolvent. Two of the main option are:

Creditors’ Voluntary Liquidation

A Creditors’ Voluntary Liquidation (CVL) is a very common solution used by insolvent companies to reach the best possible outcome for the company, its directors and its creditors. While it does result in the closing of the insolvent company, it ensures directors fulfil their obligations to creditors, while also providing certain legal protections and other advantages.

As a voluntary procedure, directors can appoint an insolvency practitioner of their choice to liquidate their company. The liquidator will take the reins of the company. They will identify any company assets, sell them at the highest price possible, and distribute the proceeds amongst outstanding creditors. Once all possible distributions have been made, the company will be wound up and struck off from the Companies House register. If any debts remain at this stage, they will be written off, with the exception of debts secured by personal guarantees. 

If you would like more details about Creditors’ Voluntary Liquidations, read our CVL guide.

Business rescue

For directors of insolvent companies who have a solid business model underneath their financial issues, business rescue could be an option. In essence, this process seeks to restore an insolvent company to profitability, though how it does so can vary.

For some companies, a business rescue plan could involve selling off unprofitable segments of the company, cutting costs and raising cash. For others, business rescue will involve refining a viable business model, streamlining processes, and making operations more efficient. In any case, a business rescue plan can help improve a company’s finances, allowing it to repay its outstanding creditors and return to solvency.

Clarke Bell can help you

If your company is showing any signs of being insolvent and you want to know what to do now, just give us a call.

Clarke Bell have more than 29 years of experience in helping directors to deal with the debt problems of their company. 

We have helped companies of different sizes, across a wide range of different sectors. So, we will be able to help you.

Call us now for your free advice on how you can deal with your company’s debt problems.