To start with, its important to note that insolvency does not solely relate to failing businesses; viable and profitable businesses can also find themselves in these dangerous waters as well, which is why Acting early is the key to surviving business insolvency. This is where the following tips on how to save an entity from insolvency come in handy.
What Is Insolvency?
Insolvency refers to a situation where a business entity is unable to make payments on its obligations when they become due. It is important to know when a business becomes insolvent to ensure that directors do not make any risky decisions that may end up exposing them to personal liability down the road.
How Is Insolvency Determined
For a business to be said to be insolvent, it must be assessed using two main tests; these include the balance sheet and cash flow tests.
The balance sheet test is used to establish whether the entitys assets can be able to cover all its liabilities if it were to be liquidated. The consequence here is that creditors who make supplies after the insolvency date may not be paid if the business were to be wound up.
The cash flow test on the other hand seeks to establish whether the entity has enough money to pay its debts as they become due.
How To Get Through Insolvency
Directors simply cant continue trading after their business becomes insolvent to ensure that they dont contravene the law. Heres a list of steps they can use to get through the insolvency period without exposing themselves to undue legal exposure.
Leading And Lagging
Properly managing the collection of debts owed to the entity by customers as well as debts owned by the company to creditors can help steer the company from insolvency. You can negotiate for extended credit payment periods, while collecting debts from customers earlier.
Another way to get out of insolvency is through a capital injection. Additional cash from directors can help meet immediate cash needs of the company. It is however worth mentioning that this cannot help a company that has been making losses as the additional cash will be used up in no time.
Selling Off Or Factoring Assets
The company can sell off assets that have been completely depreciated at fair market value, and then use the proceeds to meet immediate cash requirements. Alternatively current assets may be factored in a bid to raise immediate cash.
Restructuring In The Long Term
Viable businesses that are found to be insolvent may reap more from restructuring than any of the above mentioned remedies. This is because the root problem may be traced to how they are structured.