Insolvency Test
Contents
Cash Flow Test
Balance Sheet Test
Legal Action Test
Overview
The insolvency test is defined in section 123 of the Insolvency Act 1986. It's used to assess if your company is insolvent, which means that it's unable to pay its debts as they fall due. There are three commonly used insolvency tests: the cash flow test, balance sheet test & legal action test.
It's important to seek the advice of a professional, such as an insolvency practitioner, accountant or solicitor, to determine if your company is insolvent and to ensure that your company cannot be accused of wrongful trading or insolvent trading.
A formal insolvency procedure, such as liquidation or administration, may be necessary to deal with your company's insolvency and ensure that its creditors are treated fairly.
Cash flow test
The cash flow test is a method used to check if a company is insolvent, meaning it is unable to pay its debts as they fall due. This test focuses on a company's ability to meet its current financial obligations, rather than its overall financial position.
The test works by comparing the company's income to its expenses payments for a specific period of time. If your company does not have sufficient money to meet its current obligations, it is considered insolvent under the cash flow test.
The cash flow test is often used with the balance sheet test, which looks at a company's overall financial position by comparing its assets and liabilities, to determine if a company is insolvent.
It is important to note that being unable to meet current financial obligations is not the only factor that determines insolvency. Other factors, such as the company's ability to generate future income and its financial position in the long term, should also be considered. It is always recommended to seek the advice of a professional, such as an accountant or attorney, to determine if a company is insolvent.
Balance sheet test
The balance sheet test is a solvency test used to assess your company's financial health. It compares the company's liabilities (what it owes) to its assets (what it owns).
If your company's liabilities are greater than its assets, it means the company is insolvent, meaning it is unable to meet its financial obligations.
The balance sheet test helps to determine the financial stability and viability of a company, providing insights into its long-term prospects.
Legal Action Test
If your company has received any legal enforcement actions against it, e.g. a County Court Judgment (CCJ), this could be another strong indication of insolvency.
A winding-up petition or a statutory demand also fall into this category, so if you’ve been presented with either of these it’s important that you immediately seek professional advice.
Legal actions taken by creditors (the people or businesses your company owes money to) can be a sign that your company is insolvent.