Insolvency and solvency tests for businesses

There are two main ways to check if a company is financially stable: the balance sheet test and the cash flow test

The balance sheet test looks at what a company owns and what it owes. If the debts are more than the assets, the company is a “balance sheet insolvent”. 

The cash flow test checks if the company can pay all its bills on time. If a company can’t cover its debts and expenses with the money it has, it is a “cash flow insolvent”.


What tests assess the financial health of a UK company, the balance sheet or the cash flow tests?

If your business is facing financial issues, as a director, your initial task is to understand its current status. It’s crucial to figure out if your company is financially stable, moving towards insolvency, or already insolvent. Continuing to trade when aware of insolvency is a serious matter. Failing to act upon this knowledge may lead to penalties for wrongful trading.

Two key tests determine your company’s solvency. It’s essential to undergo both tests to accurately assess your company’s current financial condition.


The Balance Sheet Test

The balance sheet test examines all your company’s assets, such as stock, debtors, cash on hand and in the bank, and any property, vehicles, or machinery without financial burdens. These assets are compared against your company’s debts, whether owed to banks, HMRC, employees, suppliers, or other creditors.

When creating your balance sheet, honesty is crucial—neither understating nor overstating your position. For instance, if you’re owed money for an extended period and despite efforts, it’s unlikely to be paid, consider writing it off as bad debt. Keeping it as an asset can distort your figures, providing false hope and optimism. While it may offer short-term relief, it worsens your situation in the long run.

The balance sheet test answers the question: ‘Does your company have more assets or liabilities?’ If it shows more debts than assets, you’re technically insolvent, requiring immediate action. An insolvency practitioner can guide your next steps.

If your company’s assets exceed liabilities, it’s not technically insolvent. However, selling assets to settle debts can harm your business. Although being asset-rich is positive, liquidity is crucial. Many companies have assets but struggle with cash flow, impacting their ability to trade. If day-to-day payments are challenging, complete the cash flow test for a comprehensive view of your situation.


The Cash Flow Test

Cash flow is vital for any business. It ensures timely payments to staff, suppliers, and bills, and provides funds for purchasing stock to sustain trading. When cash flow diminishes, operations can come to a standstill, and financial troubles escalate swiftly.

The cash flow test assesses if a company can meet its obligations when they arise. In this test, consider your current financial commitments and those coming up soon. If your company struggles to cover day-to-day expenses, seeking professional assistance becomes a priority to prevent your situation from worsening.


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How Vanguard Insolvency can help

If your company faces financial challenges, Vanguard Insolvency provides a team of insolvency experts ready to assist. We can guide you through various business rescue and recovery options to revive your business. Alternatively, if closing your company is the preferred choice, we can discuss the optimal approach. Contact us today to schedule a free, no-obligation consultation with a licensed insolvency practitioner.

David Jackson MD
Senior Partner at Vanguard Insolvency Practitioners | Website

I am an insolvency professional with a distinguished career specialising in commercial insolvency, adeptly navigating Creditors Voluntary Liquidation, Company Voluntary Arrangements, and Company Administrations. With a comprehensive understanding of insolvency laws and an unwavering commitment to ethical practices.