Posted: 17 Jan, 2019
As the director, you are legally responsible for the smooth running of your business, both financially and operationally. If your business is running out of money, experiencing cash flow issues and facing pressure from creditors, it is your duty as the director to ensure that you are not trading as insolvent.
If you continue trading in the state of insolvency, you could be held personally liable for the debts of the business. By doing so, you could be found guilty of wrongful trading; this is when you continue trading after falling into insolvency with no real intention to repay creditors. If you are found guilty of wrongful trading, you could be banned as a director for 15 years.
Test your business for insolvency
As a company director, you should have an understanding of insolvency and recognise if your business is falling into this state. The following tests can help pinpoint the weaker areas of your business and how the company can be revitalised.
Cash flow test: A steady cash flow is important for any business because if there is higher outflow than inflow, the business is spending more than it can afford. A strong cash flow is required to be able to set money aside to pay employees, suppliers, bills and stock. If this falls short, it will create a knockback effect on the rest of your business, slowing down operational performance.
If your business is unable to pay debts when they are due and is forced to apply for a payment extension, this is a sign of falling into insolvency. If the business is cash poor, the bank will typically refuse to increase overdraft facilities and extend any loans. If cash flow issues are left unresolved, the financial health of the business can soon fall into decline.
Balance sheet test: This insolvency test is imperative as it accounts for the assets and liabilities of the business. This should also include future liabilities to give an accurate indication of the true value of the business. If there are more liabilities than assets, this shows that the business has a lack of security to pay off creditors.
The cash flow and balance sheet test provide a clear illustration of the financial health of the business. If the business is in the position of financial distress, an insolvency practitioner will be able to determine the best next steps for your business, whether this is liquidation, closure or restructuring.
Legal action: Legal action can be taken against your company, such as a winding up petition or a statutory demand when a business is unable to repay debts to creditors. As a result, the court can demand for payment to be made to a creditor or call for the liquidation of your business. If the court suspects that you are guilty of wrongful trading, you could face director disqualification.
If your business is insolvent, there are a number of steps that can help rescue your business from a dwindling balance sheet and a short flow of working capital. As the driver of the business, you can explore formal and informal options if there is a clear prospect of recovery.
This step can be taken in order to reduce the amount of debt owed by the business by streamlining operational structures to cut costs and raise money for creditors. By restructuring the business, it will minimise financial liabilities and help the business become profitable again.
Company Voluntary Agreement (CVA)
A company voluntary arrangement is a formal insolvency procedure which can help the business recover from cash flow problems. By appointing a licensed insolvency practitioner, they will take control of negotiating repayment terms with creditors. As the director, you will be responsible for turning the fortunes around for the business by securing new sales and cut costs where appropriate.
During the negotiation of the company voluntary agreement, interest and extra charges will be frozen. Creditors will also be unable to take legal action against the business whilst the terms of the CVA are adhered to.
In order to make the repayments affordable and easy to track, these will be merged into one single payment, freeing up working capital for the business. This ease of pressure may be what is needed to help the business profit.
A licensed insolvency practitioner will be appointed as the administrator of the business giving them control over the company assets. They will be able to sell business assets in order to raise cash for creditors. By entering into company administration, creditors will be unable to take legal action against your business.
As the director, it is your duty to ensure that creditor debts are repaid to pull your business out of arrears. This option is best if the business is asset rich as the funds generated from asset sales can help pay the debts off faster.
If your business is in a battle against creditors due as a result of having more debt than assets, if you believe that the business has no real chance of recovering, an insolvency practitioner will be able to advise you on the best route to take to close your business, such as liquidation.
Keith Tully is a partner at Real Business Rescue Advisory. He specialises in advising large companies on turnaround and restructuring solutions. He is knowledgeable in an array of business-related topics but his specialities include acting on behalf of financial institutions and negotiating time to pay schemes with HMRC.
Back to Knowledge Hub