It’s easy to get drawn into the view that every company is different but the fact is that often companies show the exactly same signs of being in trouble.
It is important that directors take swift action to avoid any accusations of wrongful trading, where the company continues to trade in the full knowledge that it won’t be able to pay its debts, as to do so may lead to court action to recover any additional losses that accrue.
Company Law in England and Wales requires that all directors take steps to ensure that they are cogniscent of the facts surrounding their company and even if they are not financial experts they must show due care and exercise reasonable expertise in dealing with the firms finances.
There are two major tests that for insolvency;
The Cash flow test. Can the company pay its bills as they fall due? If the business does not have enough free cash to pay creditors when they are due then it is insolvent. If the firm has a reasonable prospect of trading out of insolvency in the very short term then it may be arguable that the directors can continue to trade or a Company Voluntary Arrangement (CVA) may be an option. On the other hand, if the business will not be able to pay its debts then directors must take action immediately that this becomes apparent.
The second test is the balance sheet test. This is where the liabilities of the business exceed the assets. Whilst in some cases a new start may have a weak balance sheet, profitable trading will continue to strengthen it. However a firm with a weak balance sheet that continues to make losses will eventually become insolvent and should seek liquidation.
There are however a number of signs that company directors can look out for to check that insolvency is not a possibility.
- The company receives a CCJ. A County Court Judgement is a successful claim in court by a creditor. CCJs are limited to claims under £50,000 and should not be a surprise when the order hits the mat. Any firm that cannot pay a relatively small debt, and which hasn’t managed to either settle a dispute or make an arrangement to pay with the creditor may well be in serious trouble
- There is a threat of High Court action. The High Court is for claims over £50k and if action for a large amount is taken then this could cause major issues for the business. Similarly if a CCJ or High Court order has been granted and bailiffs turn up at the company then directors know that there is a problem.
- There has been a significant drop in trade. If a business suffers a very large drop in trade compared to its overall turnover, such as a major customer choosing to buy from a competitor, then they may be unable to cover their fixed costs. Whilst it is possible for a firm to cover this from cash flow in the short term it is likely that the lost sales will either need to be replaced with a new buyer or the firm will need to restructure.
- The company suffering a large bad debt that will severely impact cash flow? This may be a very large contract that will not pay out due to the insolvency of the eventual customer or many smaller sales to single purchaser.
- Uncleared HMRC debts. A firm that has historical debts that it cannot clear with HMRC is likely to face action in short order. Long standing and rising balances with the taxman cannot be ignored.
What is vital is that company directors take swift and decisive action. Simply ignoring the issue and hoping it will go away is not an option.
It is possible that an insolvency practitioner can make an assessment of the problems and advise the directors on the best course of action. Informal agreements can be reached with major creditors, retrenching and restructuring may be proposed or the more formal CVA, Pre-pack or insolvency are all routes that could be looked at.
Businesses all suffer short term setbacks however Directors must ensure that small localised problems are not symptoms of a wider problem with their business. Looking out for these key signs will help identify the times when the action needs to be taken to deal with the problem in hand.