Insolvency – Recognising It

Useful for: Business (including not-for-profit)

In Brief

  • A company is insolvent if it is unable to pay its debts as and when they fall due, having regard to current and expected cash flow assessed having regard to the nature of the business and the balance sheet of the company.
  • There are a number of factors indicative of insolvency, but Courts also take into account balance sheet factors and the “commercial reality” of the business when determining whether it is insolvent or whether lack of liquidity can be addressed and the company remain viable.
  • Temporary lack of liquidity does not equal insolvency, but companies should keep track of their liquidity ratio from time to time. The liquidity ratio formula is:
    • current assets/current liabilities. That is, divide the total amount
      of current assets by current liabilities.
  • If the liquidity ratio is 1 or more, this means that current assets should be adequate to discharge current liabilities at that point in time.

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