The second primary test is the balance sheet test, which values an organisation’s assets to determine whether both existing and future liabilities can be met.
It is important to consider the future rather than simply focusing on the current position, as the organisation must be seen as viable beyond the current difficulties. Failure to meet this condition is taken to mean the organisation is insolvent.
As long as the estimated value of all of the organisation’s assets exceeds all of its liabilities, then the organisation is considered solvent and able to meet its ongoing obligations. The problems begin if the asset valuation does not cover all liabilities. If this is the case, the organisation is deemed insolvent because it cannot support either its current liabilities or its future ones, and thus is not a going concern.
The balance sheet test is used to ensure all creditors are treated fairly in the event that the organisation is insolvent. If an organisation was insolvent simply on the basis of the cash flow test, those creditors who provided goods and services after the organisation was insolvent lose out as the deficit between assets and liabilities cannot be resolved. For the purpose of fairness, both the cash flow test and the balance sheet test are applied together to assess an organisation’s viability.