If your business is experiencing long-term financial struggles, you may find that your company needs to take urgent action rather than bide time and hope to reach a position of stability. If you can no longer meet essential payments and maintain your financial affairs, your business may be edging closer to failure. If you decide to ignore signs of dwindling cash flow and a poor balance sheet, you may risk more than just the success of your business. Trading while insolvent can result in serious repercussions and you may be personally reprimanded for disregarding creditor interests.
There are two actions which can result in an Insolvency Service Investigation that you should be aware of- Insolvent Trading and Wrongful Trading, governed by the Insolvency Act 1986.
What is Insolvent Trading?
Insolvent trading is when a business continues to trade and go about daily life when it has run out of funds. To understand insolvent trading, you will need to recognise what makes a business insolvent. Some ways you can test for insolvency include:
- Cash flow test: By assessing company cash flow, you will be able to calculate if you have enough funds to meet payments, such as staff wages, utility bills and finance repayments. If cash flow is due to run out, this is a red flag that your business is likely to fail without the extra income to replenish cash flow.
- Balance sheet test: A company balance sheet is essentially an inventory of company assets, such as equipment, machinery, property, investments, including non-tangible property which when realised, can generate financial value, such as patents and copyright agreements. If company liabilities outweigh assets, this shows that your business is in danger and is due to become insolvent if you continue on the same track.
It is important to note that a business may not be insolvent permanently and indefinitely, as by conducting a suitable restructuring exercise, such as a Fast Track Company Voluntary Arrangement (CVA), CVA or putting the business into administration, the company could be returned to a healthy position. Alternatively, you may wish to sell your business and attract a buyer who is cash-rich and highly skilled in your sector, making them better placed to operate the company.
What is wrongful trading?
Wrongful trading is when a business continues to trade when it can no longer pay debts when they are due. This is typically due to poor judgement as the director is hoping for the situation to resolve.
If proof is found that a director continues trading with no intention to make repayments, they can be found guilty of fraudulent trading. If you are liquidating your company, it is common practice to launch an investigation into director conduct to ensure that all the prescribed directorial duties were fulfilled. If the licensed insolvency practitioner finds evidence of fraudulent trading, this will be reported to the court.
What are the consequences of wrongful trading?
If you are found guilty of intentionally defrauding creditors, you could be disqualified as a company director for a maximum of 15 years and be fined. You will also be at risk of being held liable for company debts if you commit the civil offence.
If you find yourself in this situation during the liquidation process, seek advice from a licensed insolvency practitioner. Cases of wrongful or fraudulent trading are treated seriously by the courts, so it is instrumental to seek expert advice concerning insolvency before falling foul of serious offences.
Find out more about insolvency.