A business is insolvent if it doesn’t have sufficient assets to cover its debts, or it is unable to pay its debts as and when they are due.

If you monitor your business’ actual performance against your budget and the cashflow forecast regularly, this will give you an early warning of potential problems. You can then take action to avoid insolvency.

This guide provides information on how to reduce the risk of insolvency by suggesting actions to take and sources of advice. It also describes possible outcomes of insolvency for different types of business.


Improve cashflow

Keeping cash flowing into the business is a challenge for many small companies.

There are several ways to improve your cashflow situation:

  • Bill promptly – invoicing promptly and regularly helps ensure a steadier flow of cash into the business. Negotiate regular payments across the life of any long-term contracts.
  • Avoid overtrading – don’t continue to accept orders and try to fulfil them if you don’t have enough cash or resources to do so. See our guide on how to avoid the problems of overtrading.
  • Recover debts – chase up any debts owed to you. See our guide on managing late payments.
  • Trim your inventory – excess inventory ties up your cash. Take the time to plan a stock reduction programme. See our guide on stock control and inventory.
  • Renegotiate your credit limits – adjust payment dates and credit limits with your main suppliers.
  • Factoring – sell outstanding invoices to a third party, known as a factor. Factors pay some of the debt off in advance of collection. See our guide on factoring and invoice discounting: the basics.
  • Sell assets – raise cash by selling under-utilised assets and then leasing them back. However, you must sell the assets at their true price and check whether the sale will result in a profit or a loss.

You can also approach your bank to discuss the possibility of extending your finance. Try not to worry the bank unduly, as they could call in any overdraft and make matters worse. See our guide on cashflow management: the basics.

Download guidance on cashflow from the Chartered Institute of Management Accountants (CIMA) website (PDF, 366K)- Opens in a new window.

Talk to your accountant as they can offer practical advice tailored to your business needs. For more information, see our guide on how to choose and work with an accountant.


Negotiate with creditors

Any creditor, or group of creditors, owed more than £750 can ask a court to wind up your business. For this reason you should not ignore your creditors – it is important to answer their letters and calls.

Talk to your creditors before you become formally insolvent, as you may be able to find a compromise on your payment terms. Be realistic and honest about what you can afford to repay them. Try approaching creditors who would be lower down the list of who gets paid off in the case of insolvency as they are more likely to co-operate.

If you find you can’t meet the conditions of a renegotiated payment plan, contact your creditors in advance. Send as much of the funds as you can with a promise to make up the rest, or renegotiate the deal. Don’t wait until the deadline for your repayment has passed to contact a creditor.

Read information on how to handle debts on the Business Debtline website- Opens in a new window.


Reduce overheads

It’s a good idea to review overheads regularly. It becomes even more important if you are having problems generating cash. You may need to make big cuts in overheads, but try to avoid slashing costs to a level where it is difficult to operate.

Advertising, as well as research and development, are often the first activities to be cut because they can be reduced almost instantly. Cutting overheads such as property costs or capital goods will take much longer to have an effect on the balance sheet.

You can also cut staff costs by restricting overtime or cutting staff hours.

You could also consider reducing your number of employees – though redundancy payments will increase costs in the short term. However, the consequences of redundancies can be devastating, particularly for small businesses, and morale could suffer. Key employees may feel insecure and choose to leave your business. It can be useful to talk to employees before taking such action. They may suggest less drastic ways of cutting costs.

You can also reduce overheads, eg by delaying purchases of new equipment, although this is a temporary measure. Investment is crucial if you want to grow your business and ensure it remains competitive.

Other short-term measures for cutting costs include:

  • letting out part of your business premises – but check first with the owner or mortgage company that sub-letting is allowed as approval may be needed
  • leasing new equipment rather than buying it outright
  • renegotiating your contracts with suppliers

Importance of advice when avoiding insolvency

It’s a good idea to take financial and legal advice as soon as your business starts getting into trouble. This will give you time to assess the alternatives open to the business.

You should seek professional advice immediately if:

  • you cannot cover your debts
  • the business receives a County Court summons
  • you can’t pay staff wages
  • there is an acute lack of working capital

Your accountant, who may already be familiar with your business, may be able to advise you.

You can also find an insolvency practitioner with The Insolvency Service. Alternatively, find an insolvency practitioner on the R3 website- Opens in a new window.

Insolvency practitioners are bound by a code of practice based on five principles of integrity, objectivity, competence and due care, confidentiality and professional behaviour which ensures that they carry out their work to high ethical standards.

Directors should seek legal advice if their company becomes insolvent. You can find a solicitor on the Law Society website- Opens in a new window. Directors are required to make an early decision on whether the company should cease to trade. If you are the director of a company facing financial difficulty, you will need to be sure that the company has reasonable prospects of avoiding liquidation, before taking the decision to continue trading.

Directors need to be aware of their position regarding the business’ situation as they may be found:

  • personally liable as a result of any personal guarantees
  • criminally and personally liable for fraudulent trading, ie deceiving creditors, if the company goes into liquidation
  • personally liable for wrongful trading, ie trading while the company is insolvent, if the company goes into liquidation

Directors may be disqualified if they are found liable and could face criminal proceedings.


Possible outcomes for limited companies

If you cannot avoid insolvency, you need to consider how to deal with it. There are several options for limited companies. Please note that this page provides basic guidance. For more detailed guidance, see our section on insolvency information for limited companies.

Liquidation

A business ceases trading when it is liquidated, ie when its assets are sold to pay creditors. Creditors owed more than £750 can ask the court to wind up your business. This is known as compulsory liquidation. Shareholders can also decide to wind up the business and ask the creditors to appoint a liquidator. This is known as voluntary liquidationRead liquidation and insolvency FAQs on the Companies House website- Opens in a new window.

Company voluntary arrangements

You can use an insolvency practitioner to prepare and negotiate a company voluntary agreement between you and your creditors. This is a schedule of when you will make repayments to creditors. A meeting will be held to present your proposals to creditors, 75 per cent – by value – of creditors present or voting by proxy must vote in favour of the arrangement for it to be binding on all parties. Recent amendments to insolvency rules allow for meetings, voting and communications to be made using electronic means as well as in person. You can find an insolvency practitioner with The Insolvency Service. Alternatively, find an insolvency practitioner on the R3 website- Opens in a new window.

Administrative receivership

This is where a holder of a floating charge (usually a bank) appoints an administrative receiver (who much be an insolvency practitioner) to recover money owed to it. The court is not usually involved. A company in administrative receivership is also said to be “in receivership”. The administrative receiver’s task is to recover enough money to pay their costs, the preferential creditors, and the floating charge holder’s debt. An administrative receiver does not make payments to unsecured creditors.

Under the Enterprise Act 2002, the holders of a floating charge created after 15 September 2003 can appoint an administrative receiver only in connection with floating charges granted in relation to:

  • certain transactions in capital markets
  • public/private partnerships
  • utility projects
  • finance projects
  • financial markets
  • registered social landlords

For more information see our guide on insolvency: the basics.

Administration

An administrator, whose role is to deal with problems and get the company trading again if possible, may be appointed by the court, certain specified creditors or the business itself.

The administrator must perform his or her functions with specific objectives.

First, to rescue the business; second, if that isn’t feasible, to achieve a better result for the business’ creditors as a whole than would be achieved by winding the business up; third, if the first or second options are not practicable, to do his or her best for the secured and preferential creditors without unnecessarily harming the interests of the business’ creditors as a whole.

An administrator runs the business and calls a creditors’ meeting to decide what to do next.


Insolvency outcomes for partnerships and sole traders

Individuals who become insolvent have slightly different liabilities and procedures to companies in the same situation. This page contains basic guidance. For more detailed guidance, see our sections on insolvency information for sole traders and individuals and insolvency information for partnerships.

Bankruptcy

An individual can be made bankrupt by a court if they are insolvent, ie they don’t have sufficient assets to pay their debts, or are unable to pay debts when they are due.

Bankruptcy is the procedure whereby an individual may be declared insolvent. If you trade as a sole trader, in a partnership or have given a personal guarantee for the debts of a limited company, you are liable for these debts and can be made bankrupt. An insolvency practitioner or the Official Receiver takes control of your estate, acting as trustee, and sells or converts your assets to pay creditors. For more information, see our section on insolvency information for sole traders and individuals.

Individual voluntary arrangement

Reaching an individual voluntary arrangement with your creditors is an alternative to bankruptcy. This is generally achieved through a schedule of repayments which has to be approved at a meeting of your creditors. At least 75 per cent – by value – of creditors present or voting by proxy must vote in favour of the arrangement for it to be binding on all parties. You will need to use a licensed insolvency practitioner when preparing your proposal to the creditors. If you fail to keep to the terms of your proposal then you are liable to be declared bankrupt.

You can find an insolvency practitioner with The Insolvency Service. Alternatively, find an insolvency practitioner on the R3 website- Opens in a new window.

Partnership insolvency

Insolvent partnerships can be dealt with by:

Again, an insolvency practitioner will be able to advise on the steps to take.

Recent amendments to insolvency rules allow for meetings, voting and communications to be made using electronic means as well as in person.

Debt Relief Orders

Individuals with few assets, less than £15,000 of debt and little surplus income may be eligible for a debt relief order, if they meet the stringent criteria. The order lasts for 12 months and prevents creditors from taking any action to recover or enforce their debts during that period. At the end of the 12 month period, the listed debts will be discharged.

To apply, individuals must approach an approved intermediary through one of the registered competent authorities for the process. The intermediary will assist with the completion of the application and The Insolvency Service will approve those applications which meet the criteria.

You can read information about debt relief orders in our guide on insolvency options for individuals: Debt Relief Orders.


Every effort has been made by the author(s) to ensure this article’s accuracy but it does not constitute legal advice tailored to your circumstances. If you act on it, you acknowledge that you do so at your own risk. We cannot assume responsibility and do not accept liability for any damage or loss which may arise as a result of your reliance upon it.