If a company insolvent meaning, it means that it is no longer able to pay its debts. Several signs can indicate that a business is close to insolvency, including late reporting to HMRC, missed payroll payments and declining cash flow. Insolvent companies are unable to convert their assets into cash so they must sell them off or use the proceeds of a liquidation process to pay their debts.

In order to determine whether a company is insolvent, the courts use two tests, the balance sheet test and the cash flow test. The balance sheet test compares the value of a company’s assets against its prospective and contingent liabilities. If the value of liabilities exceeds the total value of assets, then a company is considered to be insolvent.

Making Sense of Company Insolvency: Understanding the Basics

The cash flow test is more straightforward and measures a company’s level of free cash flow (FCF) against its debts and debt-like liabilities. If the FCF is insufficient to cover the debts and liabilities, then a company is considered to be under financial stress or insolvent.

Directors of insolvent businesses can face personal liability for some or all of the company’s debts depending on the circumstances and how they handled the situation. If a director made preferential payments to certain creditors while the company was insolvent, they could be sued for wrongful trading. This can include repaying loans secured by personal guarantees or paying creditors who have a connection to the director, while other creditors suffer loss.