Company in Financial Difficulty? Is Liquidation Necessary?
A company in financial difficulty does not automatically need to enter liquidation. Understanding the company’s debts, cash flow, assets, expected income and future trading position is important before deciding whether formal insolvency proceedings are actually necessary.
We were recently contacted by a company director who wanted a second opinion after seeking advice elsewhere.
The company was experiencing financial pressure and the director had initially approached another professional simply to understand his options.
He came away from that discussion believing that he was trading whilst insolvent and that the company needed to enter liquidation.
By the time he contacted DCA Business Recovery, he was worried that continuing to trade meant he was doing something wrong.
Once we looked more closely at the figures, however, the position was not as straightforward as the headline level of debt suggested.
Assessing a Company in Financial Difficulty
The company was still actively trading and had liabilities totalling approximately £70,000.
On the face of it, £70,000 of company debt sounds significant. But when assessing a company in financial difficulty, the total amount owed is only one part of the picture.
The makeup of that £70,000 was particularly important.
Approximately:
- £30,000 was owed to the director through his director’s loan account;
- £30,000 related to VAT which had not yet fallen due for payment; and
- the company had approximately £40,000 of work in progress expected to generate income.
The company was also continuing to trade.
There was undoubtedly financial pressure and cash flow needed to be monitored carefully.
But that is very different from automatically concluding that a company must immediately enter liquidation.
Does a Company in Financial Difficulty Have to Liquidate?
No.
A company in financial difficulty does not necessarily need to be liquidated simply because it has significant liabilities.
The Insolvency Service explains that a company may be insolvent where it cannot pay its debts when they fall due or where its liabilities exceed the value of its assets.
These are commonly referred to as the cash-flow test and the balance-sheet test.
The Insolvency Service also specifically states that even where a company is insolvent, this does not always mean that it must immediately stop trading.
Read the Insolvency Service guidance on company insolvency.
The important question is therefore not simply:
“How much does the company owe?”
Instead, directors should consider matters such as:
- when liabilities actually fall due;
- what money is expected to be received;
- whether customers are likely to pay;
- the company’s available cash and assets;
- whether ongoing trading is profitable;
- whether new liabilities can be paid as they arise; and
- whether there is a realistic route through the company’s current difficulties.
At DCA Business Recovery, we explain these issues in more detail in our guide to business advice for company directors.
Why the £70,000 Debt Figure Did Not Tell the Whole Story
In this case, simply looking at the £70,000 liability figure could create a misleading impression.
£30,000 was owed to the director
A director’s loan owed by the company to the director remains a company liability.
However, its practical significance may be very different from, for example, an unpaid supplier actively threatening legal proceedings.
It was therefore important to understand the nature of the company’s liabilities rather than treating every £1 owed in exactly the same way when considering immediate cash-flow pressure.
£30,000 of VAT was not yet due
The company also had approximately £30,000 of VAT which had been included within the overall liability figure but had not yet fallen due.
That VAT still needed to be planned for and ultimately paid.
However, a future tax liability is not the same as an overdue liability that the company is presently unable to meet.
If HMRC liabilities are becoming difficult to manage, directors should take advice early. Our guide to HMRC debt and company financial difficulties explains some of the options that may need to be considered.
Approximately £40,000 of work was expected to turn into income
The business also had approximately £40,000 of work in progress.
Expected income should never simply be assumed to arrive. Directors need to consider when it will be invoiced, when customers are likely to pay and whether the income will be sufficient to meet forthcoming liabilities.
But it was nevertheless an important part of the overall financial picture.
The company was not simply sitting with £70,000 of unpaid debts and no business activity or prospect of further income.
Was the Company Trading Whilst Insolvent?
That question cannot properly be answered simply by looking at one headline debt figure.
The Insolvency Service describes insolvency as either being unable to pay debts on time or having liabilities greater than the company’s assets.
Government guidance on the duties of directors when a company is insolvent also explains that, once a company becomes insolvent, directors must consider the interests of creditors and ensure that they do not worsen the financial position.
That does not mean that every company experiencing cash-flow pressure must immediately cease trading.
In fact, Government guidance expressly recognises that an insolvent company may sometimes continue trading after appropriate professional advice has been obtained.
For directors concerned about this issue, we have a separate guide explaining whether an insolvent company can continue trading.
Why We Did Not Recommend Immediate Liquidation
Based on the information presented to us, we did not consider that the circumstances justified simply recommending an immediate liquidation.
The appropriate course was instead to consider the company’s expected receipts, future liabilities and ongoing trading position.
The director needed to keep cash flow under close review and make sure that the company could realistically deal with liabilities as they fell due.
If that position deteriorated, further advice would be required.
But seeking insolvency advice does not mean that an insolvency procedure must follow.
Sometimes the right advice is that a Creditors’ Voluntary Liquidation (CVL) should be considered.
Sometimes a business may need to negotiate with creditors or review its cash-flow position.
And sometimes a director simply needs confirmation that there is not currently a reason to rush into a formal insolvency procedure.
When Is a Creditors’ Voluntary Liquidation Appropriate?
A Creditors’ Voluntary Liquidation, commonly known as a CVL, is a formal insolvency procedure generally used where a company cannot pay its debts and there is no realistic prospect of the business recovering.
The directors and shareholders take steps to place the company into liquidation and a licensed insolvency practitioner is appointed as liquidator.
The Government’s guidance on Creditors’ Voluntary Liquidation confirms that the process is used where a company cannot pay its debts.
A CVL can be the right solution for a company which has reached the end of the road.
But it should be recommended because the company’s circumstances justify liquidation — not simply because the company has debts or is experiencing a difficult period.
Professional Advice Carries Weight
There was another important aspect to this case.
When directors speak to an insolvency professional, they will often place considerable reliance on what they are told.
Many are already worried about their company and uncertain about their legal responsibilities.
Being told that they are trading whilst insolvent, potentially doing something wrong or need to liquidate can therefore have a significant impact.
That does not mean insolvency professionals should avoid giving difficult advice.
Where a company needs to enter liquidation, that should be explained clearly.
If continuing to trade is likely to worsen the position for creditors, directors also need to understand that risk.
But professional advice should be based on a proper assessment of the circumstances.
The purpose of an initial conversation should be to understand the company’s position, explain the options and help the director make an informed decision.
It should not begin with the assumption that every director who asks about financial difficulties needs a liquidation.
Taking Advice Early Can Give Directors More Options
One positive aspect of this case was that the director sought advice before the company’s position had reached a crisis point.
Directors do not need to wait for:
- HMRC enforcement;
- a County Court Judgment;
- a statutory demand;
- bailiff action;
- a winding-up petition; or
- a completely exhausted bank account
before asking for professional advice.
The Insolvency Service encourages directors to address financial problems early and notes that doing so may allow a company to avoid formal insolvency proceedings.
Read the Government guidance on dealing with company debts.
Early advice can help establish whether the business is viable, what liabilities need to be dealt with and what action should be taken next.
Most importantly, it can allow those decisions to be made before circumstances dictate the outcome.
Worried About a Company in Financial Difficulty?
If your company is experiencing financial difficulties, you do not need to decide whether it should be liquidated before speaking to us.
That is what the initial advice is for.
At DCA Business Recovery, we provide free, confidential initial advice to company directors.
We will look at the company’s actual financial position, discuss its debts and expected income and explain the options available.
If the business can continue, we will tell you. If liquidation is appropriate, we will explain why.
There is no obligation to proceed with a formal insolvency process simply because you have asked for advice.
Call 01702 344558 or contact DCA Business Recovery for a confidential discussion.
