What does insolvency mean?
Insolvency is one of those terms people often hear when a business is under pressure, but it’s rarely explained in a clear or reassuring way. It can sound final or intimidating, especially when it appears alongside words like debt, creditors or closure.
In reality, insolvency is a financial position, and is not always the end of the road. In this article, we explain what it really means and how to spot issues earlier, take control of the situation, and avoid reactive responses.
What is insolvency?
In simple terms, insolvency means being unable to pay debts as they fall due or owing more than you own. In the UK, there are two main ways to assess insolvency.
The first is the balance sheet test. This compares what the business owns against what it owes. If liabilities exceed assets, the company may be classified as insolvent, even if day-to-day operations continue.
The second is the cash flow test. This assesses whether a business can pay its bills on time, including to suppliers, lenders, and HMRC. Even if a company has valuable assets, it can still be insolvent if it lacks sufficient cash to meet obligations as they fall due.
Insolvency vs bankruptcy
Insolvency and bankruptcy are often used interchangeably, but they’re not the same thing. Insolvency describes a financial state. Bankruptcy is a formal legal process for individuals, not companies.
In the UK, businesses don’t go bankrupt. Instead, an insolvent company may enter a formal insolvency procedure such as administration, a company voluntary arrangement or liquidation.
Understanding this distinction is important because insolvency doesn’t automatically trigger a specific outcome. It simply shows that action is needed.
How does a business become insolvent
Most businesses don’t become insolvent overnight. It’s usually the result of ongoing pressure rather than a single event. Common causes of insolvency include:
- Customers paying late, affecting your cash flow
- Rising operating costs
- Loss of a key contract or client
- Over-reliance on borrowing
- Poor financial visibility or forecasting
- National pandemics or government changes in policy
Even well-run businesses can find themselves in difficulty if market conditions change or unexpected costs appear. Insolvency is often about timing and cash rather than long-term viability.
Early signs of insolvency
There are usually warning signs before insolvency becomes unavoidable. These signs are easy to ignore when you’re focused on keeping the business moving, but they’re important signals that shouldn’t be dismissed.
Common indicators include struggling to pay suppliers on time, falling behind on VAT or PAYE, relying on credit to cover everyday expenses or constantly juggling payments to stay afloat.
Directors may also feel under constant pressure from creditor calls or letters. Spotting these signs early can make a significant difference.
What happens when a business is insolvent?
Once a business is insolvent, directors have legal responsibilities to act in the best interests of creditors. That doesn’t mean the business must close immediately. Depending on the circumstances, there may be options to restructure, rescue or wind down the company in an orderly way.
Formal insolvency procedures exist to provide structure, protect stakeholders and ensure decisions are made fairly. The right option depends on the business’s financial position, future prospects and the goals of those involved.
Why early action can improve insolvency outcomes
The earlier the insolvency is acknowledged, the more options are available. Taking action early can help protect the business, limit personal risk for directors and reduce overall stress. It also allows time to explore solutions rather than being forced into decisions by creditors or deadlines.
Are you looking for insolvency advice?
If you’re facing financial difficulties or you’re worried about insolvency, then take the first step toward clarity and peace of mind – call us now on 0800 612 6197 for a free, confidential consultation. Our experts will provide guidance tailored to your situation, helping you feel supported, informed, and confident in moving forward.
Categorised in: Insolvency Reviews & Advice
