When in a hole you MUST stop digging - when insolvency strikes

As business owners we are invariably optimists. Things will get better. Work a bit harder. Tweak a few things.

But what if the business is insolvent?

This can creep up on a business. One or two unprofitable projects, a significant bad debt perhaps and all of a sudden cashflow is extremely tight. The definition of insolvency is a business not being able to meet its payment obligations to creditors when they fall due. This is not a short term cashflow blip, but something more systemic. On the balance sheet liabilities will exceed assets. Of greater concern is when short term liabilities - bank overdraft, tax due and payments due to suppliers exceed cash and payments due from customers.

In this situation the directors of the business have legal obligations. They can't just keep calm and carry on. Choosing to pay some creditors in preference to others when the business is insolvent is a legal offence and the directors could be held personally liable if the business fails.

The choices for the directors are:

1. Contact all creditors and see if you can reach an informal agreement

It is recommended that a financial projection is prepared in advance of any discussions with creditors so that there is a realistic view of what is affordable. A turnaround plan may involve deferring payments on 'old' debt whilst keeping up to date with new obligations. It is critical that the plan shows that the business is profitable going forward. This is likely to require significant cost cutting and restructuring

2. A Company Voluntary Arrangement

This is where an Insolvency Practitioner is engaged to make binding arrangements with creditors. Unlike the informal arrangements at 1 above, this is a formal arrangement the creditors must adhere to. The company can continue to trade during the CVA

3. Administration

Again this is a formal arrangement where respite can be gained from creditors and the company can continue to trade. Property may need to be sold to cover debts

The final option is liquidation where the company is wound up and any assets are sold and distributed to creditors

So when the company is insolvent, carrying on as normal is not an option. The choices listed above must be followed or the directors will be open to the charge that they treated some creditors more favourably than others

With speed and resolve, following option 1 can turn a company round and bring it back to stability. If action is taken too late, it is more likely that the business will fail and liquidation becomes the only option.

If you think your business may be insolvent I would recommend an urgent discussion with your company accountant.

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