Corporate Insolvency: The Importance of Being Able to Pay Your Debts

by Martin on May 14, 2012

Why is it so important to know if your company can meet its debt obligations?

Because this forms the basis upon which the solvency of your company is assessed.  If your company cannot meet its debts as and when they fall due, then it is insolvent and appropriate action must be taken to protect both the company and its officers from consequences such as the officers being disqualified from acting as company directors in future, or becoming liable for the debts of the company.

The two tests that can be applied appear straightforward:

  • The cash flow test checks if the company can meets its obligations as they arise
  • The balance sheet test checks whether there are more assets than liabilities.

If a company is deemed to be unable to meet its obligations and/or there are more liabilities than assets on the balance sheet, it can be insolvent.  This requires the directors to take advice from an insolvency practitioner to clarify the situation and recommend a course of action that could involve continued trading but could also involve closing the company down.  Directors have obligations to meet, thus taking professional advice when things look problematic can be the best thing to do.

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