Your guide to Balance Sheet Insolvency (2024)

Balance sheet insolvency is a type of corporate insolvency that may affect a company with limited assets and high debts.

If a company is facing balance sheet insolvency, it demonstrates they are in serious financial difficulties. If the situation can’t be rectified and the company’s finances turned around, then the end result could be closure and liquidation in order to pay debts.

In this article, the expert team at Irwin Insolvency answers the question, ‘What is balance sheet insolvency?’

What Is Balance Sheet Insolvency?

Balance sheet insolvency is the most serious form of insolvency that companies can face. Like all types of insolvency, balance sheet insolvency means that a company is unable to pay its debts as and when they arise.

What distinguishes this type of insolvency from other types is that even if the company were to sell all of its assets, it would still not be able to pay off the money it owes to creditors.

In technical terms, balance sheet insolvency is therefore defined as when a company has more liabilities – which includes loans, mortgages, unpaid invoices, supplier credit, etc. – than it has assets. Balance sheet insolvency also precludes the fact that a company has no cash left in its accounts to pay creditors and therefore must sell assets to cover its bills. Those assets aren’t worth enough to cover its bills if they were to be sold.

This means that if your company were to default on its loans, even if you were to sell all of your company’s assets – such as cars, computer equipment or property – the money that could be raised would not be enough to pay those loans back.

Balance sheet insolvency is one of the official types of insolvency outlined by the United Kingdom’s Insolvency Acts. They define balance sheet insolvency as occurring when a company ‘has more liabilities on its balance sheet than assets’.

The Insolvency Acts of 1986 and 2000 have established precedents for insolvency, and there are very few options available to companies that are experiencing balance sheet insolvency. It’s very likely that a company will need to be liquidated in order to pay off at least part of its debts, if no other solutions can be found and implemented quickly. If you’re worried that your company is in a state of balance sheet insolvency or may experience this soon, it’s important to ask for independent financial advice immediately.

What Is Cash Flow Insolvency?

Cash flow insolvency is another type of insolvency also defined by the UK’s Insolvency Acts. If your company is experiencing cash flow insolvency, you are also in serious financial trouble and should seek the advice of an insolvency practitioner as soon as possible.

As the name suggests, cash flow insolvency doesn’t concern assets. Instead, it’s defined by the Insolvency Service as occurring when a company ‘can’t pay bills when they become due’. Cash flow insolvency means that a company has more money going out than coming in. This means that the company’s books are unbalanced, the accounts are in the red, and when bills become due they will go unpaid.

Cash flow insolvency is the most common type of insolvency, but it’s also a type of insolvency that can be survived with a cash injection. In fact, your company could technically experience ‘cash flow insolvency’ when you are waiting for a customer or client to pay you. This however is not an immediate precursor for liquidation.

Cash flow insolvency can only occur when a company has enough assets to cover its outgoings. This means that if a creditor were to chase a company for the money owed to them, the company could sell its assets to cover these costs if necessary.

For example, your company is in a state of cash flow insolvency and cannot pay the lease payments on a vehicle when it comes due. The company can sell the vehicle (an asset) to cover the cost of the bill. The company survives, minus its asset.

Learn how to improve your business cash flow

What’s the Difference Between Cash Flow and Balance Sheet Insolvency?

Cash flow insolvency and balance sheet insolvency might be two types of company insolvency, but it’s important to remember that there are fundamental differences between the two.

The most important difference is the seriousness of each type of insolvency. Balance sheet insolvency is a much more serious state for a company to be in than cash flow insolvency. While there are many solutions for cash flow insolvency, it’s very difficult to find solutions for balance sheet insolvency, particularly at short notice.

Cash flow insolvency concerns a company’s cash flow. While this can be a serious issue, it’s not quite as damaging as balance sheet insolvency. It can be helpful to view cash flow insolvency as a short-term problem in this respect, as a quick injection of cash from an investor can solve the cash-flow issues. With balance sheet insolvency this isn’t always possible, as it means the company has large debts that even its assets couldn’t cover if sold. In this situation, balance sheet insolvency often results from long-term neglect and mismanagement rather than short-term cash problems.

The two are different, but they are also interconnected. Cash flow insolvency can lead to balance sheet insolvency if not dealt with early on. Often, a company will first find itself struggling to make payments. If this leads to cash flow problems, then the company may have to sell assets to pay its bills.

If this continues, the company may enter a downward spiral as it loses more assets and continually struggles to pay its bills as and when they become due. Eventually, there will not be enough assets to sell, and the company may need to be liquidated if it cannot pay its debts.

What Is the Balance Sheet Test for Insolvency?

If your company is struggling financially, it may have to undertake a balance sheet test for insolvency.

Simply put, the balance sheet test for insolvency adds up all of the potential liabilities a company has and all of its assets. If the value of all liabilities is more than the sum of the assets, the company is experiencing balance sheet insolvency.

This includes liabilities that have already come due and liabilities that are due to fall shortly. Liabilities include all debts, payments and money owed to creditors, ranging from utility bills and mortgages, to wages, pension payments and taxes. Assets will include everything that has capital value, including vehicles, property, hardware, brand names, and more. To be accurate, a balance sheet test for insolvency must include all liabilities and all assets.

If you have creditors chasing you for overdue payments, you may find your company is taken to court as creditors try to take back their money. In this case, the courts will order your company to take a legal balance sheet test for insolvency. This will show if, according to the legal definition, your company is unable to pay its debts even if its assets are sold.

If this is proven, you could find the company is liquidated and any assets you have are sold to pay off creditors.

What Is the Cash Flow Test for Insolvency?

A cash flow test for insolvency is used to determine if a business has enough cash in its accounts to pay its bills as and when they are due.

A cash flow test will look at a company’s total liabilities and add all of them up. This includes all of the liabilities already discussed above. It will then look at the amount of cash a company has in the bank, and the amount of cash it’s owed or that will fall due shortly. If the total number of liabilities is more than the amount of cash held by or owed to the company, it is considered to be in a state of cash flow insolvency.

If a company fails the cash flow test then it’s deemed to be legally insolvent and it could be wound up by the courts. However, this is often an extreme option, as there will be insolvency options available that could put the company’s cash flow back on track. Failing a cash flow test demonstrates that your company needs to be turned around if it’s going to survive insolvency.

What Are the Options Available to Insolvent Companies?

If your company is facing insolvency, this doesn’t automatically mean that your business will need to fold, particularly if you act early and take on the advice of a professional insolvency practitioner.

If your business is in a state of cash flow insolvency, there are several key options available to you. This includes trying to source new investment or loans to cover the cost of the bills you owe, which is preferable to selling off assets to cover payments.

Balance sheet insolvency is much more complicated to solve, but it’s not impossible. If you have run out of cash, then you may be taken to court by creditors seeking to forcibly liquidate your company. If they were successful, then you would be forced to sell off any remaining assets to cover the money you owe them, even if there wouldn’t be enough to pay everything or everyone.

Compulsory liquidation needs to be approved by the courts, who will not only run a balance sheet insolvency test, but will assess the likelihood of success if the company wasn’t liquidated. If they believe the company could be saved, then it may be preferable for those involved to agree to a range of insolvency options, rather than liquidation.

For all insolvent companies, there are several key insolvency tools that may be initiated by an insolvency practitioner. These all provide you with an important lifeline that may save the company from liquidation. The most common insolvency tools include:

Company Voluntary Arrangement (CVA)

A formal agreement that’s made between company directors and creditors. A company voluntary arrangement is a legally binding arrangement that’s overseen and negotiated by an insolvency practitioner. A CVA may result in renegotiated credit agreements, payment extensions or consolidated loans, with the aim being to save the company so that creditors can be paid the money owed to them. While a CVA is in place, creditors cannot take further action against the company.

Administration

A company is placed under the control of a licensed insolvency practitioner who then acts as an administrator. The administrator takes over company operations, and attempts to either sell the business or parts of it to pay debts, or turn the company around and save it. If successful, the company may continue trading or find a new owner.

Administrative Receivership

Administrative receivership is similar to administration, the difference being that while administration is undertaken in the interests of all creditors, an administrative receiver is appointed by a single creditor to oversee the company. This means that the administrative receiver runs operations and sells assets for the benefit of the creditor that appointed it, which may see the company wound down entirely.

If all these measures fail, company directors may elect to voluntarily liquidate the company. This is a final measure, but it does allow the directors to have more control over the liquidation process, and may ensure that staff are treated fairly and that the winding-up process is a smoother affair than compulsory liquidation.

Contact Irwin Insolvency to Find Out More About Balance Sheet Insolvency

If your company is facing financial difficulties, you could be at risk of balance sheet insolvency. Irwin Insolvency’s experienced financial advisors can advise you on the risks and possible measures to rectify your company’s financial situation.

Our team of expert insolvency practitioners has decades of experience assisting companies through tough economic times, and we’re ready to help you escape insolvency and become financially sound.

Contact Irwin Insolvency today to book your no-obligation consultation.