Businesses across the UK have been impacted by the COVID-19 pandemic for over a year and, as a result, many are struggling with cash flow problems.

Some companies will find that they are now insolvent (i.e. they cannot pay their bills and/or their liabilities are greater than their assets) and the directors will want to know what options are open to them to best deal with that fact.

As a director of company which is experiencing cash flow problems, you are likely to be thinking about a lot of things, such as:

• Our company has a decent chance of surviving, but needs some guidance
• I took out a Bounce Back Loan, but I can’t repay it
• We have too much business debt – including a backlog of rent, deferred VAT or salaries
• I have taken money out of my company, but I’m not going to be able to repay it (an Overdrawn Director’s Loan Account)
• My company has been issued with a CCJ / winding-up petition
• I want to close this company and start a new business
• What happens to a personal guarantee?
• Are our books and records in good order?
• Did we (inadvertently) make a ‘preferential payment’ that could impact our liquidation – i.e. where you paid one creditor (e.g. a family member) in preference to any others (e.g. HMRC)?
• Have our dividends been paid in line with the insolvency regulations?

At Clarke Bell we know that being the director of an insolvent company can be overwhelming. That’s why our expert team are here to help you.

There are a number of different routes which an insolvent company can take, including a pre-pack administration, liquidation and business rescue, each one tailored to your own company circumstances.

To help you answer some of those questions, below we take a look at everything you need to know about business insolvency, from how to test for it to the options available.

What is the balance sheet test?

To determine whether it is insolvent, a business must take the balance sheet test. The aim of the balance sheet test is to establish whether your company has more assets or liabilities.

The first step of the balance sheet test is to look at all parts of the company’s assets. This includes everything from stock, cash in hand and in the bank, vehicles, machinery and equipment, the debtor book and any unencumbered property.

Next, these assets should be compared with the company’s liabilities. These include debts to HMRC, the bank, your employees, your landlord, suppliers or any other creditors.

Having carried out this assessment, you should be able to answer the question of whether your company has more liabilities or assets.

If the balance sheet test shows that you have more assets than liabilities your company is solvent. This means that your business is viable and that its assets could be used to pay off your creditors, if required.

If, on the other hand, the company liabilities outweigh the assets, this indicates that it is insolvent and you will need to take the necessary steps to resolve the situation.

If this is the case, you should speak to your accountant and a Licensed Insolvency Practitioner. They will work with you to assess the situation of your company and find the best steps for you to take – making sure that you fulfil all your legal obligations as the director of an insolvent company.

Doing nothing is not a recommended option.

If you fail to act and don’t pay back creditors what they are owed, your company might be forced into compulsory liquidation which can have a variety of negative impacts on the director.

Even if your company is not insolvent and is asset rich but cash poor this can impact your ability to continue trading. So, if you are facing problems making day to day payments, it will be important to complete a cash flow test which will help you gain a full understanding of your situation and any cash flow problems you may have.

What is the cash flow test?

Every business knows that cash flow is key. A healthy cash flow lets a company pay its staff, suppliers, creditors and bills on time whilst ensuring you have the money to buy things like stock and supplies when needed.

The cash flow test is the second stage in determining whether a business is insolvent which aims to identify whether a company can pay its bills when they are due.

Frequently delaying or missing payment deadlines can be a sign that your company is insolvent. For this reason, it’s essential to keep a close eye on your business cash flow and aim to regularly update a cash flow model in order to understand your situation and help to avoid cash flow problems.

Being unable to pay debts puts the company at risk of being issued with a winding-up petition and potentially being forced into compulsory liquidation.

If your company is presented with a winding up petition this means that creditors you owe money to are taking serious steps to retrieve what they are owed and close down your company. In this case you should get the help of an insolvency expert as soon as possible, to prevent things from getting worse and to challenge the winding-up petition if possible.

By acting quickly, more options remain open to you to either rescue the business or close and liquidate it voluntarily. These include:

• Creditors’ Voluntary Liquidation (CVL)
• Company Voluntary Arrangement (CVA)
• Pre-Pack Administration

To find out more about winding up petitions and what to do if you are issued with one, check out our handy, comprehensive guide.

If you have acted quickly and avoided compulsory liquidation, the next step is to see which route will be the best option for your company. This will depend on your company’s particular circumstances and financial situation.

Understanding the difference between cash flow and profit

Running a successful business is all about making a profit, or so we’re often told. In truth, that’s only part of the picture and the state of a business’ cash flow can often be a better indicator of the health of the business. A profit-making business can still run into serious trouble if it doesn’t manage its cash flow effectively so it’s vital to have a clear understanding of the difference between cash flow and profit.

Also Read: How To Use The Corporate Insolvency Test

Profit

In simple terms, profit is a narrow term that describes the amount left over from sales revenue once all business expenses have been deducted. Sales revenue itself is simply the amount that a customer pays for a business’ product or service. For example, if your business is able to provide a product or service for £50 in total costs and you can sell it for £100, your business has made a £50 profit.

Cash Flow

In contrast, a business’ cash flow covers all the money that comes in and out of the company. This includes sales and other business operations, as well as financing and investment. It’s all very well making a profit on paper but what if your customer is late with payment and your business has bills that need paying? If your business calculates its financial accounts using the accrual method, you need to be able to work out not only your accrual profits but your cash flow profits too.

Accrual Accounting

Accrual accounting is a method that shows how well your business is doing over an extended period of time by tallying your company’s income as well as expenses. Income is accrued as soon as you make a sale, regardless of whether you receive the cash immediately or not. Likewise, expenses are recognised as soon as they are incurred, rather than when the money is paid. This is different to cash accounting which recognises a sale in terms of income only when cash is received, and an expense only when cash is paid out.

While cash accounting will more accurately represent the cash flow of a business, most accountants recommend the accrual method for calculating business health. Although there will be a difference in terms of timing between business income and expenses versus cash inflows and outflows, you can work out your business cash flow profit by using a balance sheet for the period in question and making adjustments to your accrual profit.

Calculating Cash Flow Profit

To calculate the cash flow profit of a business, you should start by deducting depreciation expenses from your net profits. Depreciation expenses show the annual cost of the assets that are required for your business operations. After calculating depreciation costs, you’ll need to make further adjustments to reflect increases or
decreases in Accounts Receivable and Payable, as well as changes to your Inventories and Notes Payable.

Understanding the difference between revenue and profit, cash flow and net cash flow is key to running a healthy and successful business.

What is a Creditors’ Voluntary Liquidation (CVL)?

One option for insolvent companies is a Creditors’ Voluntary Liquidation.

A CVL is initiated by the company director and allows them to close their insolvent company when it is no longer feasible for it to keep going.

This could be a good option for a business that has undertaken the balance sheet test and cash flow test and has established that it can’t pay its bills and its liabilities outweigh its assets.

A CVL is a process that is initiated by the directors of the company that stops it trading and liquidates its assets in order to pay back its creditors. 75% of shareholders must vote to agree to the CVL in order for it to progress.

This is a good option for directors who want to take control of the situation before they are forced into compulsory liquidation.

As a formal insolvency process that liquidates your company, a licensed Insolvency Practitioner must be appointed to carry out the CVL.

It might be time to consider a Creditors’ Voluntary Liquidation if:

• Your business has run out of cash and it can no longer pay its bills or debts as they are owed
• Your business no longer seems sustainable
• You are being threatened with a winding-up petition by creditors who are owed money
• You are concerned that you will build up further debts.

If any of these apply to you, a Creditors’ Voluntary Liquidation will let you close the company quickly and in a professional manner.

One of the main benefits of a CVL is that it allows the director to liquidate the company whilst meeting their legal obligations to pay back creditors. This helps to protect your reputation as a director and leaves a wider variety of options open to you.

By undergoing a CVL, you are also showing that you acknowledge your legal duties to creditors and avoid any risk of wrongful trading.

However, if you want to rescue the business, rather than liquidating it, you will need to look at another set of options.

What is a Company Voluntary Arrangement (CVA)?

A Company Voluntary Arrangement is an option open to businesses wanting to turn the company around and restore profitability.

This is because a Company Voluntary Arrangement lets an insolvent company form an agreement with creditors to pay back its debts over a fixed period of time, typically between 3 – 5 years.

For this reason, this is a great option for businesses that have a real chance of turn around and recovery, and means they don’t have to go into liquidation, whether through compulsory liquidation or Creditors’ Voluntary Liquidation.

A licensed Insolvency Practitioner (IP) must be appointed to carry out the CVA. The IP will work closely with company directors and their accountant to draw up a proposal to demonstrate how the company will pay back creditors and a schedule under which they will do so. This has to be agreed by 75% of creditors and at least 50% of shareholders to progress.

Your company is eligible for a CVA if it meets the following conditions:

• Your company is insolvent
• The director and Insolvency Practitioner believe it has real chances of recovery and can once again become sustainable and rebuild profitability
• It can show projected cash flow forecasts that indicate it has enough funds to cover the repayment terms outlined in the agreement.

There are many benefits to a Company Voluntary Arrangement, these include:

• It stops your company from going into liquidation and being dissolved
• It stops legal action being taken against your company: this is because once a CVA has agreed by all parties and the court, no legal action can be taken against it
• It stops repayment demands from parties that are owed money, whether that is creditors or HMRC.

There is another option open to insolvent businesses:  Pre-pack administration.

What is a Pre-pack administration?

Pre-pack administration is another option open to companies facing cash flow problems.

This is a process that involves putting an insolvent company into administration and selling the business and its assets. The sale of the business must be arranged before it is put into administration to ensure there is a suitable buyer.

Like with a CVL and a CVA, a pre-pack administration is a formal insolvency process that is legally required to be overseen and carried out by a licensed Insolvency Practitioner who will review the company’s activities to determine whether it can be sold and whether jobs and business relationships can be maintained.

Once the IP has made a thorough assessment and confirmed a suitable buyer, they will next agree on the terms of the sale.

A company would typically use a pre-pack administration if:

• It is experiencing cash flow problems and can’t pay creditors what they owe
• There is a potential buyer for the business
• It is likely that the purchasing company of the business can make a success of it
• The value of the business would be depleted if it were to be first placed into an insolvency procedure before being advertised for sale
• Liquidation is not an option

There are several benefits to pre-pack administration:

• it typically allows more jobs to be saved, with some or all existing employees being transferred to the new company
• offers a better return for the secured creditors
• it achieves a greater realisation of assets than would occur in liquidation
• preserves the value of the company due to the speed of the process. After all, the longer the sales process is, the more likely the company’s value will be depleted as people including clients, suppliers and staff become aware that the company is having problems

In November 2015, the Pre-Pack Pool (PPP) was set up to provide independent advice for purchasers where a planned sale of a business to a connected party is being considered.

Details of the PPP can be found at: www.prepackpool.co.uk – on which it describes The Pre-Pack Pool as:

“…an independent body of experienced, professional business people who will compile a report on the purchase of a substantial disposal of a business and/or assets by an administrator of an insolvent company, where a connected party is involved.”

The current application fee (payable to the PPP) is £1,500 +VAT.

It is optional for potential purchasers to use the PPP but we, as Insolvency Practitioners, must advise you of its existence (as stated in the Statement of Insolvency Practice 16). However, we consider the approval of the PPP to be essential and we will not accept administrations that have not been approved.

The business must be marketed for sale prior to the appointment of an administrator. This is to ensure that the very best outcome is achieved for creditors.

Do You need a Business Rescue?

Lots of businesses face insolvency and sometimes the best option is to liquidate the company. However, it might be the case that your company can be rescued. The goal of business rescue is to turn a business around and return it to profitability.

There are different business rescue options in which an Insolvency Practitioner will need to be involved. These include:

• Company Voluntary Arrangement (CVA)
• Administration

A company that enters administration is protected against all legal action for 8-10 weeks. Once an administration order is approved, the administrator will be appointed to oversee the company’s operations.

The Insolvency Practitioner draws up a recovery plan which must be approved by the majority of the company’s creditors at a creditors’ meeting. The administrator must, by law, act in the best interests of the creditors. However, by creating a rescue plan that enables the repayment of as many debts as possible, the company’s position also improves. During this period the business will continue to trade under the administrator’s control. Typical exit routes are a sale of the business or a successful CVA proposal.

However, unfortunately, business rescue isn’t always successful. If business rescue fails, the next step for it will be to liquidate.

This is the process of liquidating a company’s assets and then closing it down.

The final result is that the company is dissolved and struck off the Companies House register.

Another option is pre-pack administration. As we have already mentioned, this involves putting an insolvent company into administration and selling the company and assets.

Could a COVID-19 moratorium help your business?

Many companies will have faced financial difficulties during the COVID-19 pandemic.

However, there is some good news for these companies, as, thanks to the Corporate Insolvency and Governance Act 2020, companies have a new solution to help them survive these difficult times.

On 26 June 2020 new rules came into play to help companies with considerable problems which have been caused by the COVID-19 pandemic.

This is a solution for a strong company, not a so-called ‘zombie’ company. This means that the government doesn’t want the procedure to be utilised by a company that does not have a chance of recovery as it is not a means of postponing a formal insolvency procedure.

The new rules have been designed to help companies that:

• Are facing cash flow problems due to COVID-19
• Were performing well before the pandemic struck
• Have been built on solid foundations
• Need some time to pay their bills and debts
• Will once again prosper when the pandemic is over

A key provision of the Act is the new ‘debtor in possession’ Moratorium procedure.

This gives a business 20 business days’ protection from certain creditor action, as opposed to the previous ‘creditor in possession’.

A monitor, who must be a licensed Insolvency Practitioner, must be appointed to oversee the moratorium, but they will leave the existing management to run the company’s day-to-day business and directors will be in charge of the business.

The legal monitor is appointed to support the integrity of the moratorium process and ensure that the creditors’ interests are protected. Directors must provide any information required by the Insolvency Practitioner to carry out their functions. If directors don’t comply with this, the monitor can file a notice at court to bring the moratorium to an end.

Under new rules, the director is able to choose which Insolvency Practitioner they wish to appoint.

During the moratorium period certain conditions apply, including:

• No winding-up petition can be presented to the company to force them into compulsory liquidation
• No order may be made for the winding-up of the company
• An administration application can’t be made.

Typically, a moratorium period would be followed by a CVA. We envisage previously strong companies with a healthy underlying business would require a “breathing space” CVA – lasting no more than 12 months.