What is Insolvency?

Legal Definition and Signs of Company Insolvency


The legal definition of Insolvency is set out in Section 123 of The Insolvency Act 1986 and sets out two tests to consider whether a company is insolvent.

  1. The Cashflow Test says that a company is insolvent if it is unable to pay its debts as and when they fall due.  Therefore, while a company may have significant capital assets, if it does not have sufficient cash to pay a bill when it falls due then it is considered insolvent.
  2. The Balance Sheet Test says that if a company’s liabilities are greater than its assets then it is insolvent.


Put simply creditors are chasing for the amounts that are owed to them, and there is insufficient monies available to pay them at the time. 


If a company is considered insolvent then it can be placed into an Insolvency Procedure such as:

  1.   Creditors Voluntary Liquidation
  2.   Compulsory Liquidation
  3.   Administration
  4.   Company Voluntary Arrangement


(More information in respect of each procedure can be found by clicking on the above links.)


More often than not however action can be taken before a company or business is formally insolvent to try to prevent a formal insolvency, or implement a controlled wind down of the company.


Signs of Insolvency

Typical signs of insolvency are:

  1.   The company is constantly juggling which creditor to pay over another.
  2.   The company is “robbing Peter to pay Paul.”
  3.   There are arrears with HM Revenue and Customs or the landlords.
  4.   The company is constantly making late payments or extending credit terms.
  5.   There are threats of Court action, statutory demands or winding up petitions.


If any of these signs are present then it may be a good idea to speak to a Licensed Insolvency Practitioner to obtain advice on the Company’s finances and the options available to it.


Quite often insolvency does not have to be a terminal affair and the underlying business or company can be saved as a going concern provided that advice is taken early.


If you would like to discuss your company’s affairs and obtain some free insolvency advice please contact Chris Parkman on 01305 458 383 or email him at chris@purnells.co.uk.