Insolvency is defined in the Insolvency Act 1986 and there are two types:
- Cash flow insolvency which is when a company cannot pay its bills on time.
- Balance sheet insolvency which is when the company’s assets are worth less than the total of its liabilities.
Generally speaking, cash flow insolvency is the bigger risk, particularly for small businesses. It comes about through a vicious circle, particularly in difficult trading times. The deadline for paying bills is missed, but the company cannot boost trading in order to generate extra cash to pay the bills because the money needed to fund increased trading is not available. So with no increase in trade, the bills continue to go unpaid.
Directors whose companies have become insolvent usually face a crucial decision; whether to inject personal monies into an often ailing business or to begin formal insolvency procedures, such as company liquidation.