What are balance sheet tests?
A rather wide question. In the context of insolvency, a balance sheet is deemed to be insolvent if it shows negative shareholders’ funds. This situation usually arises out of continued loss making activity. However, a company can have positive shareholders’ funds and still be technically insolvent. This latter situation usually arises where a company has significant fixed assets supporting its balance sheet, i.e. freehold property, plant and machinery etc, although its current assets, i.e. the assets that it uses to trade with on a daily basis being stocks, debtors etc, are less than its current liabilities, i.e. the amounts it owes to its suppliers.
What is balance sheet insolvency?
The definition of insolvency is “the inability to discharge your liabilities as and when they fall due”.
To demonstrate this, we have set out below an example of a balance sheet, that, whilst showing the company to have positive shareholders’ funds, on a technical basis, is actually insolvent.
| Fixed assets | £000 | £000 |
| Freehold property | 860 | |
| Plant & machinery | 390 | |
| Current Assets | ||
| Stock & WIP | 540 | |
| Debtors | 430 | |
| Total current assets | 970 | |
| Creditors less 1 year | (1530) | |
| Net current liabilities | (560) | |
| Net assets | 690 | |
| Share Capital | 1 | |
| Profit & loss account | 689 | |
| Shareholder’s funds | 690 |
What are cash flow tests?
This is slightly easier to explain and to some degree follows the premise described above. Cash flows are perhaps more important than the traditional profit and loss statement, given that without the ability to pay suppliers, most company’s life’s will be fairly short. Cash flow is the absolute heart of any business. There is little point in making paper profits, if your customers/clients are not paying on time and causing you problems with paying your suppliers. A sale with a decent margin is only of real value to you once you have been paid. Debtors on the balance sheet do not pay the bills – as is evidenced by the balance sheet above.
Control over cash flow is absolutely critical if you are to manage your company’s finances effectively. It is fairly important therefore to run and regularly update a cash flow model. This doesn’t have to be complicated – all you really need is to input forecast sales with the timing of forecast receipts and against that enter known payments due.
A simple cash flow forecast will highlight when you may have a problem in paying suppliers on time. None of us like to consider bad news, but you are much better off being made aware of a potential problem at as early a stage as possible, in order that you may then have more time to try and find a solution to the problem.
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If you are experiencing cash flow problems, contact us today. We will provide free advice and a no obligation consultation. Call or fill in our enquiry form and one of our licensed insolvency practitioners will get in touch with you within 24 hours.
We have offices in London, Nottingham and Derby, so we are well placed to support businesses UK wide. We are happy to travel to meet you at a convenient location.
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