Avoiding insolvency |
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| Introduction |
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| A business is insolvent if it doesn't have enough assets to cover its debts, or it is unable to pay its debts as and when they are due. If you monitor your business' actual performance against the budget and the cash flow forecast regularly, this will give you an early warning of potential problems. You can then take action to avoid insolvency. |
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| This guide suggests action to take to avoid insolvency. It also describes possible outcomes of insolvency for different business structures. |
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| Improve cash flow |
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| Keeping cash flowing into the business is a challenge for many small organisations. Here’s how to improve cash flow: |
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- Bill promptly - invoicing promptly and regularly should help ensure a steadier flow of cash into the business. Negotiate for regular payments across the life of any long-term contracts;
Avoid overtrading - don't continue to accept orders and try to fulfil them if you don't have enough cash or resources to do so;
- Recover debts;
- Trim your inventory - your inventory ties up your cash. It's a good idea to take the time to plan any stock reduction programmes;
- Renegotiate credit limits - adjust payment dates and credit limits with your main suppliers;
- Approach your bank - discuss with your bank whether they could extend more finance. But be careful not to worry the bank unduly, as they could call in any overdraft you have and make matters worse;
- Factoring - sell outstanding invoices to a third party, known as a factor. Factors pay some of the debt off in advance of collection;
- Sell assets - raise cash by selling under-utilised assets and then leasing them back. However, you must sell the assets at their true price and check whether the sale will result in a profit or a loss;
- Negotiate with creditors any creditor, or group of creditors, owed more than £750 can ask a court to wind up your business so do not ignore creditors. If you find you can't meet the conditions of a renegotiated payment plan, contact your creditors in advance. Send as much of the funds as you can with a promise to make up the rest, or renegotiate the deal. Don't wait until the deadline for your repayment has passed to contact a creditor.
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| Reduce overheads |
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| Review overheads regularly. It becomes even more important if you are having problems generating cash. You may need to make big cuts in overheads, but try to avoid slashing costs to a level where it is difficult to operate. |
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| Advertising, as well as research and development, are often the first activities to be cut because they can be reduced almost instantly. Cutting overheads such as property costs or capital goods will take much longer to have an effect on the balance sheet. |
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| You can also cut staff costs by restricting overtime or cutting staff hours. |
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| For a longer term solution, you could also reduce employee numbers. However, consider the damaging effect of redundancy on the remaining employees. |
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| You can also reduce overheads, for example by delaying purchases of new equipment, although this is a temporary measure. Investment is crucial if you want to grow your business and ensure it remains competitive. |
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| Other short-term measures for cutting costs include: |
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- Letting out part of your business premises - but check first with the owner or mortgage company that sub-letting is allowed as approval may be needed;
- Leasing new equipment rather than buying it outright;
- Renegotiating your contracts with suppliers.
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| Importance of advice when avoiding insolvency |
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| It's a good idea to take financial and legal advice as soon as your business starts getting into trouble. This will give you time to assess the alternatives open to the business. |
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| Insolvency practitioners are bound by a code of practice based on five principles of integrity, objectivity, competence and due care, confidentiality and professional behaviour which ensures that they carry out their work to high ethical standards. |
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| Directors should seek legal advice if their company becomes insolvent. |
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| Directors are required to make an early decision on whether the company should cease to trade. If you are the director of a company facing financial difficulty, you will need to be sure that the company has reasonable prospects of avoiding liquidation, before taking the decision to continue trading. |
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| Directors need to be aware of their position regarding the business' situation as they may be found: |
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- Personally liable as a result of any personal guarantees;
- Criminally and personally liable for fraudulent trading;
- Personally liable for wrongful trading.
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| Directors may be disqualified if they are found liable and could face criminal proceedings. |
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| Possible outcomes for limited companies |
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| If you cannot avoid insolvency, consider how to deal with it. There are several options for limited companies. |
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| Liquidation |
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| A business ceases trading when it is liquidated. Creditors owed more than £750 can ask the court to wind up your business. This is known as compulsory liquidation. Shareholders can also decide to wind up the business and ask the creditors to appoint a liquidator. This is known as voluntary liquidation. |
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| Company voluntary arrangements |
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| You can use an insolvency practitioner to prepare and negotiate a company voluntary agreement between you and your creditors. This is a schedule of when you will make repayments to creditors. A meeting will be held to present your proposals to creditors, 75 per cent - by value - of creditors present or voting by proxy must vote in favour of the arrangement for it to be binding on all parties. |
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| Administrative receivership |
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| A receiver, who is appointed to pay off the firm's creditors, takes control of the business and decides whether to attempt to sell the business as a going concern or shut it down. Only a secured creditor, such as a bank, can appoint a receiver, although directors can also ask for a receiver to be appointed, for instance to avoid the risk of wrongful trading. Administrative receivership is only available for limited companies. |
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| Administration |
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| An administrator, whose role is to deal with problems and get the company trading again if possible, may be appointed by the court, certain specified creditors or the business itself. The administrator must perform his or her functions with specific objectives. |
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| First, to rescue the business; second, if that isn't feasible, to achieve a better result for the business' creditors as a whole than would be achieved by winding the business up; third, if the first or second options are not practicable, to do his or her best for the secured and preferential creditors without unnecessarily harming the interests of the business' creditors as a whole. |
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| An administrator runs the business and calls a creditors' meeting to decide what to do next. |
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| Insolvency outcomes for partnerships and sole traders |
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| Individuals who become insolvent have slightly different liabilities and procedures to companies in the same situation. |
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| Bankruptcy |
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| An individual can be made bankrupt by a court if they are insolvent. |
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| Bankruptcy is the procedure whereby an individual may be declared insolvent. If you trade as a sole trader, in a partnership or have given a personal guarantee for the debts of a limited company, you are liable for these debts and can be made bankrupt. An insolvency practitioner or the Official Receiver takes control of your estate, acting as trustee, and sells or converts your assets to pay creditors. |
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| Individual voluntary agreement |
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| Reaching an individual voluntary agreement with your creditors is an alternative to bankruptcy. This is generally achieved through a scheduleof repayments which has to be approved at a meeting of your creditors. At least 75 per cent - by value - of creditors present or voting by proxy must vote in favour of the arrangement for it to be binding on all parties. You will need to use a licensed insolvency practitioner when preparing your proposal to the creditors. This is generally a schedule of when you will make repayments to creditors. If you fail to keep to the terms of your proposal then you are liable to be declared bankrupt. |
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| Partnership insolvency |
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| Insolvent partnerships can be dealt with by: |
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- Liquidation - a business ceases trading when it is liquidated, i.e. when its assets are sold to pay creditors. Creditors owed more than £750 can ask the court to wind up your business. This is known as compulsory liquidation;
- Partnership voluntary agreements - similar to other voluntary agreements, this formal insolvency arrangement allows the partners to propose a repayment scheme. 75 per cent of creditors must approve the scheme;
- Administration - an administrator, whose role is to deal with problems and get the company trading again if possible, may be appointed by the court, certain specified creditors or the business itself. An administrator runs the business and calls a creditors' meeting to decide what to do next.
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