Trading Insolvent
Coming out of lock down, some businesses will be trading insolvent, meaning special responsibilities for their Directors. In this blog we look at the issues involved.
What is Trading insolvent?
A business is insolvent when it is not able to pay its debts. One way this is apparent is when a company is is unable to meet its debts when they become due.
It is also the case when its assets are smaller than its liabilities, ie the combined value of the money the business has in the bank, the money it is owed and the equipment it owns is less than all the money it owes to others including suppliers, lenders, HMRC.
Said another way the idea is that if you turned all the company assets into cash, you still couldn’t pay off everyone the company owes money to.
‘Trading Insolvent’ simply means that the business is insolvent but is continuing to trade.
How do we know if we are trading insolvent?
The figure you need to look for to know if the business is trading insolvent is the Equity figure right at the bottom or your balance sheet. If that figure is negative the business is insolvent.
If in doubt, we recommend to get your accounts brought up to date by an accountant because they will be trained to do the necessary adjustments for tax, accruals and prepayments.
What does it mean for the business?
There is no law against trading insolvent but it confers special responsibilities on the Company Directors and it will likely impair the ability of the business to borrow money.
Once a business is trading insolvent the Directors start to become responsible to the company’s creditors that their interests are served by continuing to trade. The accounts will need a ‘Going Concern’ note in which the Directors declare that the business is able to trade its way out its insolvency.
The idea here is that by continuing to trade the business can make profit and that the profit made can pay off its debts.
The risk for Directors is that they become personally responsible for the judgement that continuing to trade will best serve the creditors interests. If continuing to trade results in further losses, the creditors, at the limit, have an opportunity to sue the Directors for that decision.
For investors, a company trading insolvent has a history of making losses and clearly there is a risk this continues and the investor loses their money.
What can be done about it?
Obviously the best way to address the situation is to make profit. It is prudent for Directors to keep a close eye on their finances to make sure that profit is being made whilst a company is Trading Insolvent.
Investors who believe in the long term success of the business (especially the Directors themselves) may be prepared to turn loans into equity investment. The effect of this is to take a creditor off the balance sheet and turn it into share capital.
If Directors feel there is no credible plan for the business to return to solvency it is important they consider working with insolvency practitioners to close the business.