If a business is having severe financial difficulties and is struggling to pay debts and keep up with its obligations it may be insolvent or otherwise nearing insolvency.
Insolvency is something that many companies face every year, particularly in the current, tough economic climate and the temptation can be to simply ignore the problem. Some business owners may not even realise that they are insolvent or the implications to their business. It is highly recommended that business owners immediately seek insolvency advice when faced with the prospect of insolvency.
The bottom line is this: Continuing to trade whilst insolvent is illegal!
As the directory of a business you have certain legal obligations and ignorance is never a good defence, so no-matter what size your business is, it is important that you understand your financial status and take action accordingly.
You Are Insolvent If:
- You cannot pay your creditors
- You have debts that are due or overdue
- Your income is less than your outgoings
In some cases it may be possible to avoid insolvency by being upfront with suppliers and negotiating payment terms, however – if your operating cash flow is not positive this will only delay insolvency.
In this instance you should be very careful, as continuing to trade when heading towards inevitable insolvency could still be considered illegal. Directors of companies have an obligation not to trade recklessly.
Avoiding Insolvent Trading
To avoid this situation it is important that you have at least a working knowledge of your own accounts and that you understand whether your business is running profitably or not.
In most cases, issues result from business owners ‘burying their head in the sand’ when they know that they are facing problems but in reality this will only worsen your problems.
Instead, you should make the effort to understand why your business is under performing and either take steps to make it profitable again or to wind it up without accumulating further debts.
What Happens If I Trade Whilst Insolvent?
The biggest risk is simple: If you trade whilst insolvent, you are breaking the law and in some cases you can be tried as a criminal for doing so.
*The exception of course is if you have a company voluntary agreement in place, in which case your business can continue to trade as long as you continue to pay back your creditors as agreed.
If you take on any additional debt as a result of your continued trading, you are effectively taking on debt with limited liability that you know your company will be unable to repay. This may be considered fraudulent and in many cases, as a director you can become personally liable for these debts.
*Your company does not have to be legally declared as insolvent for this to apply. If you know your company is or will imminently be insolvent (or if you should reasonably know) you can still be held as liable.
In some cases, trading whilst insolvent can be considered to be ‘reckless trading’ and once your company is dissolved you can then be banned for a certain period from being a director of any other company.
In some cases, your business can continue to trade when insolvency seems close, provided that you can show you are taking steps to turn around your financial situation and are attempting to make the business profitable.
In this situation it will look favourable if you make the effort to talk to your suppliers as well as documenting an on-going strategy to create positive cash flow.
Remember that if your company is insolvent it is likely that eventually you will face liquidation and at this point a liquidator will be responsible for investigating your business and accounts.
It is often possible to ‘get away with’ wrongful trading for some time, but sooner or later a liquidator will find evidence of this trading and will then report it.
What’s The Bottom Line?
If your business is struggling financially you should ensure that you know your accounts inside out and by all means try to save your business from insolvency, but be sensible and be open with your creditors.
Secrecy and ignorance are normally the fastest ways to get into trouble and the liability to yourself can be great.
About the Author: This article was provided by Trevor Slater, a financial blogger working in the private sector.