There is an important distinction to make between balance sheet insolvency and a business that is truly insolvent. What balance sheet insolvency means is that the current state of the firm’s finances is negative when taken in the round. However, this may be a temporary issue that can be overcome. Therefore, just because an accountant or auditor declares a business to be balance sheet insolvent, it does not necessarily mean that the directors must immediately pursue insolvency proceedings or declare bankruptcy.
Far from it, in fact. According to leading professionals in UK insolvency practice, Salient Insolvency, many businesses can be turned around even when their balance sheets do not look particularly favorable. Sometimes, it is a question of prioritising or rationalising operational procedures so loss-making companies can be put on a much more sound financial footing. That said, there are some important implications of being balance sheet insolvent.
To be clear, balance sheet insolvency means that all of the liabilities a firm has, such as its tax bill, its purchase invoices and its payroll, outweigh all of its assets. Insofar as balance sheets are concerned both fixed assets – equipment, tooling, land and so on – as well as more liquid assets – money in the bank, income pending from sales invoices and so on – both count. However, if these don’t add up to a sum that is in excess of the liabilities, then the company concerned will be balance sheet insolvent.
Theoretically, balance sheet insolvency means the company cannot continue to trade. However, this is only theoretical because a firm’s tax bill or other liabilities, such as its rent payments, may not be due for a while. Under such circumstances, there may be a window of opportunity to increase the value of a company’s assets, perhaps by selling goods profitably or by rendering more services without spending a great deal.
Overall, it should be remembered that balance sheet insolvency is a very different state of trading when it is compared to cash flow insolvency. A firm that is cash flow insolvent may or may not also have more liabilities than assets but what makes it distinct is that it is not currently in a position to pay its creditors. Under this example, a company may be waiting for a large payment from a big client before it is able to settle its tax or wage bill, for example. Cash flow insolvency, like balance sheet insolvency, may also be a temporary situation but it can often be more urgent, especially if creditors think that they might not be paid and begin proceedings, such as applying for a winding up petition, for instance. It is best to seek professional help if you are a director or a partner of a firm that is currently balance sheet insolvent. There are some steps that can help to buy time to put the company on the right track, such as creditors’ voluntary arrangements, for example. Skilled business rescue professionals and insolvency practitioners should be able to offer tailored advice to see your firm move out of the red and into the black.
