Am I Insolvent? Understanding Your Company’s Financial Position
Am I Insolvent? Understanding Your Company’s Financial Position
When financial pressure mounts, it can be difficult to distinguish between a temporary cashflow difficulty and formal insolvency. The two can feel identical from the inside – but legally, they are very different, and knowing which describes your company’s position is the necessary starting point for everything that follows.
The good news is that the test is clear. Insolvency in England and Wales is not a matter of opinion or degree. It is a defined legal status, established under the Insolvency Act 1986, and your company either meets the threshold or it does not.
Understanding where you stand – honestly and specifically – is the most protective thing you can do right now, both for your business and for yourself as a director.
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The Two Legal Tests for Insolvency
Under the Insolvency Act 1986, a company is insolvent if it fails either of two tests. Failing one is sufficient – a company does not need to fail both.
The Cashflow Test
The cashflow test asks a straightforward question: can the company pay its debts as and when they fall due?
This means paying suppliers on their agreed terms, meeting payroll, and staying current with HMRC on VAT, PAYE, and Corporation Tax. If you are consistently delaying payments, using one creditor to buy time with another, or drawing on personal funds to cover business obligations, your company may already be cashflow insolvent – even if the balance sheet still looks broadly positive.
The Balance Sheet Test
The balance sheet test asks whether the company’s total assets – at current realisable value – are sufficient to meet its total liabilities, including contingent liabilities such as outstanding guarantees or disputed claims.
A company can pass the cashflow test while failing the balance sheet test, and vice versa. A profitable, cash-generative business can be balance sheet insolvent if its historic liabilities outweigh its asset base. Either test, on its own, is sufficient to establish insolvency in law.
Warning Signs to Take Seriously
Insolvency often reveals itself through practical day-to-day pressures before a formal test is applied. The following are indicators that your company may have crossed – or be approaching – the insolvency threshold.
- Personal funding. You are using personal savings, personal credit cards, or loans from family members to meet business obligations, payroll, or HMRC payments.
- HMRC arrears. You have unpaid VAT, PAYE, or Corporation Tax and are receiving formal demand letters or enforcement notices.
- Legal action. The company has received County Court Judgments, or a creditor has threatened or served a winding-up petition for a debt exceeding £750.
- Creditor withdrawal. Key suppliers have withdrawn credit facilities or are demanding payment on delivery rather than on terms.
- Maximum credit utilisation. The company has reached the limit on all bank facilities and cannot obtain further borrowing.
- Bounce Back Loan concerns. The company took a Bounce Back Loan during the pandemic and cannot service or repay it – this is a company liability and contributes to both cashflow and balance sheet assessments.
If you recognise more than one of these, seeking advice is not premature – it is overdue.
What Changes When a Company Becomes Insolvent
The moment your company is – or is likely to become – insolvent, your legal duties as a director change fundamentally. You are no longer acting primarily in the interests of shareholders. Your primary obligation shifts to protecting the interests of creditors.
In practical terms, this means three things.
You must not continue to incur new debts that the company cannot realistically repay. Trading while knowingly insolvent in a way that worsens the position of creditors is wrongful trading – and it can result in personal liability for the debts incurred during that period.
You must not dispose of assets at an undervalue or make payments that favour specific creditors over others. Paying a connected creditor – a director, a family member, or a preferred supplier – ahead of others when the company is insolvent can be challenged and reversed by a liquidator as a preference transaction.
You should seek professional advice from a licensed insolvency practitioner as soon as you recognise the signs. Doing so – and being seen to have done so – is one of the most effective ways to demonstrate responsible conduct if your decisions are ever reviewed.
Not sure where your company stands? Our first conversation will establish that clearly, at no cost and with no obligation. Contact Us
Expert Advice, Delivered Personally
The Insolvency Practitioners is an independent national firm led by Michael Chamberlain. With over 30 years of experience, Mike has helped hundreds of directors navigate the transition from financial uncertainty to a clear, structured solution.
Every director who contacts us speaks to Mike directly – not a junior, not a call handler. That is not something every firm can say.
“Many directors feel that acknowledging insolvency is a sign of failure. In reality, it is the most professional and responsible thing you can do. It is what gives us the time to explore rescue options like a CVA or a moratorium before closure becomes the only choice.”
- Mike Chamberlain, Founder & Licensed Insolvency Practitioner
A Recent Example
A director of a retail business came to us unsure whether her company was technically insolvent. She was paying most creditors on time but had fallen four months behind on VAT and was making up the shortfall from her personal account. She did not think of herself as insolvent – she thought of herself as managing a temporary problem.
Our assessment established that the company was cashflow insolvent under the legal test, and that the balance sheet position – once the VAT liability was accounted for in full – was also negative. She had not failed as a director. She had simply not known where the legal threshold sat.
With that clarity established, we explored the options. The underlying business was profitable. A Time to Pay arrangement with HMRC addressed the immediate pressure, and a CVA was put in place to manage the historic liability. The business continues to trade today.
The conversation that made the difference took less than an hour.
Immediate Steps to Take
If you believe – or suspect – that your company may be insolvent, three steps should follow immediately.
Seek professional advice from a licensed insolvency practitioner. The act of doing so, and the documentation it creates, is one of the most effective protections available to a director if conduct is ever scrutinised.
Stop incurring new debts the company cannot repay. If there is no realistic prospect of avoiding insolvent liquidation, continuing to trade in a way that worsens the creditor position is wrongful trading.
Treat creditors equally. Do not attempt to clear specific balances – particularly those owed to connected parties – ahead of others. Unequal payments made when insolvent can be reversed by a liquidator as preference transactions.
Ready to Understand Your Position?
Uncertainty is your biggest risk. Knowing clearly where your company stands – even if the answer is uncomfortable – gives you options. Not knowing removes them.
Speak to Mike Chamberlain – book a free, confidential call
Frequently Asked Questions about Insolvency
Does insolvency mean my company has to close? Not necessarily. Insolvency is a legal state, not an outcome. If the underlying business is viable, procedures such as a CVA, Administration, or a Company Moratorium can be used to restructure the business and allow it to continue trading. Closure is one possible outcome – it is not the automatic one.
Can I be personally sued if my company is insolvent? As a director, you are generally protected by the principle of limited liability. However, wrongful trading – continuing to incur debts while knowing there is no realistic prospect of avoiding insolvent liquidation – can result in personal liability for those debts. Personal guarantees and overdrawn directors’ loan accounts are additional routes to personal exposure. We assess all of these in our initial consultation.
What is a CCJ and how does it affect my company? A County Court Judgment is a formal court order requiring the company to pay a debt. Left unpaid, it damages the company’s credit rating and is frequently the first formal step a creditor takes before filing a winding-up petition. If the company has received a CCJ, the window for voluntary action is narrowing.
Should I pay the smallest creditors first to clear the decks? No – and this is one of the most common mistakes directors make. When a company is insolvent, creditors of the same class must be treated equally. Paying one creditor in full while others go without – particularly if the favoured creditor is a connected party – can be challenged as an unfair preference by a liquidator and the payment reversed.
How much debt does it take to become insolvent? Under the cashflow test, any debt you cannot pay as it falls due is sufficient. Under the balance sheet test, any excess of liabilities over assets is sufficient. However, for a creditor to force a company into compulsory liquidation, the debt must typically be over £750 and undisputed. The legal threshold for insolvency and the practical threshold for enforcement action are different things.
Is my Bounce Back Loan a factor? Yes. A Bounce Back Loan is a company liability and is included in both the cashflow and balance sheet assessments. If the company cannot service or repay it, this contributes to the insolvency position. It is important to address Bounce Back Loan obligations through a formal process rather than simply allowing the company to become dormant – the liability does not disappear if the company stops trading informally.
