Reviewed: 2nd November 2017
When a limited company experiences financial decline and insolvency becomes likely, it’s important for directors to act in accordance with insolvency laws by placing creditor interests first.
Failing to do so leaves them open to allegations of wrongful trading or misconduct. So when a Financial Director believes insolvency is suggested, based on the company’s accounts, the first step is to take professional advice.
A number of key considerations arise when a company is approaching insolvency, including:
- Maximising creditor returns
- Ceasing trade
- Director exposure to liquidator or third party claims
- Director personal guarantees
- The threat of compulsory liquidation
A licensed insolvency practitioner (IP) can establish beyond doubt the company’s financial status, and identify all potential options. Furthermore, in seeking professional advice directors demonstrate responsibility, and carry out their duty of care to company creditors.
Testing for insolvency
Two main tests for insolvency exist - the cash flow and balance sheet tests. The cash flow test identifies whether or not the company can pay its bills as they fall due – if not, the company is known as cash flow insolvent.
The balance sheet test involves calculating whether the company’s total liabilities (including contingent and prospective liabilities) exceed its assets. In this case, to provide an accurate result, all liabilities must be included in the calculation.
Although Financial Directors may already have carried out these tests, obtaining confirmation of the company’s financial situation from a licensed IP provides clarity on what to do next.
Preventing further financial loss
Having identified that the company may be entering insolvency, the Finance Director and other officers of the company must take steps to prevent further financial loss, avoiding actions that compromise creditor returns.
- Monitor the company’s debt situation
As the company’s financial position can change very quickly, daily monitoring of cash flow is crucial. Having fast access to reliable management information helps Financial Directors stay ahead of potential issues, and take the most appropriate action when needed. - Be fully aware of the company’s financial situation
It’s a director’s duty to be aware of their company’s financial position at all times. Being unaware of the financial issues a business is experiencing, or their severity, is no defence against allegations of misconduct or wrongful trading at a later date. - Don’t incur new liabilities
Ordering goods from suppliers when it’s known the business is unlikely to pay for them, reduces returns for creditors if the company needs to be liquidated. Accepting customer deposits for orders that cannot be fulfilled also makes it unlikely the customer will recover their money. - Carefully consider director salary levels
Withdrawing large salaries that cannot be supported by the company may lead to accusations of misconduct, and disqualification as a director for a minimum of two years. High salaries can contribute to a company’s financial decline, and significantly reduce returns for unsecured creditors. - Hold regular board meetings
Should accusations of wrongful trading or misconduct be made on liquidation, the fact that regular board meetings were held and discussions/conclusions recorded, demonstrates financial awareness by directors, and intent to consider and protect creditor interests. - Don’t make ‘preferential’ payments
When one creditor is paid in favour of creditors as a whole, the transaction may be regarded by a liquidator as a ‘preferential payment.’ This leaves directors open to accusations of misconduct. - Don’t dispose of assets at an undervalue
Transactions at an undervalue are those where an asset is sold at a price below its true market value, and can be reversed by a liquidator. Any assets likely to be sold should receive a valuation from an independent professional.
If your company is experiencing financial decline and you require professional assistance, our licensed insolvency practitioners at Real Business Rescue can help. We have extensive experience across all industries, and will arrange a free same-day meeting to discuss your needs. Real Business Rescue provide director advice online, over the phone, or in-person at one of our 75 UK offices or a place of your convenience.
Further Reading on Advice for Directors
Free Guide for Limited Company Directors
Business Rescue Advice for Directors
- How to manage company cash flow problems
- Advice on dealing with HMRC
- Understanding rescue and closure options
- And much more...
Business Rescue Guide for Accountants
Dealing with your Insolvent Clients
- Helping you advise insolvent clients
- Spotting signs of client distress
- Exploring business rescue options
- And much more...
