Causes of business insolvency-what are the reasons for insolvency
Causes of business insolvency
A business is deemed to be insolvent if it can’t pay its creditors on time or in full, now or in the future. There are many common causes of business insolvency, which we explore below. Our business rescue experts and licensed insolvency practitioners can provide instant, practical advice on the causes of business insolvency and how to solve them.
What are the reasons for insolvency?
Not enough cash coming into the business.
This is one of the leading causes of business insolvency. It’s natural for a company’s cash-flow to fluctuate throughout the year. But bad financial planning can mean that there’s not always enough funds to cover the quieter periods. In some cases, a business can have a constant cash flow, but if the cost of its various overheads aren’t carefully planned and considered it might still run into trouble.
The key is to keep an updated cash-flow forecast, so that the financial position of the company is transparent and any changes can be predicted and planned for.
Poor cash-flow forecasting
A cash-flow forecast is a plan that shows how much money is coming into and going out of a business over a fixed period of time (a week, month or quarter, for example). It needs to be detailed and give the timings of the payments coming into and out of the business.
The business might be making a profit but if its outgoings come at the wrong time of the month or quarter, this can be one of the hidden causes of business insolvency.
Directors drawing on company funds
The blurring of the lines between what money is the business’ and what is personal is one of the causes of business insolvency that leads to the biggest personal issues. Especially if the director is also the owner of the company.
Money might be taken from the business to cover personal debts. Or personal cash is being put into the business to clear any company payments. The crossover could have serious tax and credit implications.
Should the company become insolvent and a licensed insolvency practitioner has to ask the question ‘what are the reasons for insolvency?’, they will look at any money taken out of the company by the director(s). They also have the power to enforce its repayment.
Debt as one of the causes of business insolvency is a common one that creeps up over time, while the owner or director(s) are busy with the day to day running of things. When looking at the reasons for insolvency caused by debt, items like unpaid bills, delayed payments to suppliers, outstanding tax payments and increasing overhead costs are at the top of the list.
This brings us back to the cash-flow forecast. If the money coming into and going out of a business is carefully monitored, it’s much easier to prevent business insolvency from happening in the first place.
Too much competition
Not all competition is bad. In fact, competition is a great way to encourage innovation in an industry. However, for the businesses that leave it too late to innovate or for those that ignore the competition entirely, the reduction of profits as customers go elsewhere can sadly be one of the causes of business insolvency.
Getting feedback from and engaging with customers can create brand loyalty and give one business the edge over its competitors. Looking at ways to reduce spending while maintaining the quality of a product or service is also a must for any business that wants to stay competitive.
Relying on a single customer or source of income
Putting all a business’ eggs into one or two baskets puts it at serious risk and can be one of the causes of business insolvency: if this customer closes down or moves to a competitor, the business’ profits will suffer a huge loss. Diversifying and growing the customer base will increase the business’ stability and earn it a bigger share of the market.
How Liquidation.co.uk can advise you on the causes of business insolvency.
We can help you understand ‘what are the reasons for insolvency’ in your unique situation and talk you through your options. It’s important to remember that a company can sometimes be saved from liquidation, or a business saved and reborn through a new company.
As industry leading experts with 40 years’ experience, we’re in the best position to match any like for like quote ensuring you receive the best service for the lowest price.
How to tell if a business is insolvent?
Before looking at the causes of business insolvency, this is how to tell if a business is insolvent.
Cash-flow test: Make a list of the income the business has and the date it comes into the business’ account. Then do the same with its expenses. If there’s not enough income to meet the outgoings at the right time and in full, the business is most likely insolvent.
Balance-sheet test: Calculate the total of the business’ assets, including the value of stock, premises and equipment it owns, monies owed to it and cash in the bank. Compare this to its liabilities, such as debts to suppliers, your bank or other creditors. If the figure is negative, the business is most likely insolvent.
What is the difference between a balance sheet and a cash-flow forecast?
A balance sheet is a snapshot of a business’ financial position at that moment in time. It shows what a business owns that is worth money (its assets) and what the business’ debts and fixed outgoings are (its liabilities).
A cash-flow forecast shows the money going into and out of a business, along with the timings, over a fixed period of time. It helps to plan a business’ finances so it never drops into insolvency.
What if a director can’t pay back money to the business?
If the director(s) cannot repay money that’s been withdrawn from the business’ accounts, it could have serious personal implications – including the bankruptcy of the director(s) concerned, should the company be faced with insolvency and liquidation. If you’re concerned about this, you should contact your accountant or a licensed insolvency practitioner as soon as possible.
What are the options for an insolvent business?
In some cases, we are able to help an insolvent business by identifying the issues – like those seen above – and then working with the owner and directors to fix them.
The next stage would be to negotiate affordable repayments with creditors, perhaps using a formal tool like a Company Voluntary Arrangement (CVA). In some cases, we can use company administration to save all or part of your business. In others, a liquidation might be the answer.
We’ll talk to you about your situation and understand your aspirations for the business, before we work with you on a solution.
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