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Early Warning Signs that Your Business is Falling Into Insolvency

business insolvency concept of a lot of unpaid bills under glasses and a calculator
  • Blog
  • Jill
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  • January 19, 2021

Early Warning Signs that Your Business is Falling Into Insolvency

Starting and running a business are two incredible feats. Of course, they also come with a long list of challenges. You have to balance your work and personal life, make sure employees are paid, monitor statistics, and ensure that your company stays solvent. The last one is the greatest concern for many people, especially under the current pandemic circumstances. Fortunately, by recognizing the early signs that your business is becoming insolvent, you can take steps to remedy it. 

What Is Insolvency?

So what does it mean when a business becomes insolvent? The best explanation is that the business’s liabilities exceed its assets. In other words, it is not generating enough cash flow to cover its debts and other liabilities. Insolvency typically does not come out of nowhere, as it takes some time for a business to fully slip into this state. 

When looking at insolvency, it is also important to consider the current pandemic circumstances. While it may appear to be blatant insolvency, it could be a temporary period of lower cash flow due to pandemic circumstances, such as decreased physical business or shutdowns. These situations can be remedied through some of the government programs providing assistance to help businesses during this period. 

Testing for Insolvency

There are a couple of well-known methods that can be used to test a business for insolvency. The first of these is called The Cash Flow Test. With the cash flow test, you create an inclusive balance sheet that encompasses current working capital and a comprehensive layout of forecasted debts and sales. If cash flow coming into the business is outweighed by the liabilities coming due, then the business is insolvent. 

The second test is The Balance Sheet Test. For this one, you create two columns: one containing all company assets and the other containing current and contingent liabilities. If the liabilities outweigh the assets, then that business could be considered insolvent. On the other hand, if a company has enough assets to outweigh liabilities, then they are not completely insolvent. This is because even if cash flow is insufficient, the company could still sell off its assets to take care of the liabilities. 

Catching Insolvency Before It’s Too Late

As mentioned above, insolvency doesn’t develop overnight. Rather, it comes after a series of decreases and downfalls that eventually lead to a business being unable to pay its debts. This is why it is important to pay attention to the early warning signs, such as:

  • Inability to cover basic operating costs
  • Inability to keep up with regular debt payments on set terms
  • Increasingly borrowing money to cover wages or debts
  • Inability to pay debts even when under a court order 
  • Threats of legal action regarding unpaid debts
  • Significant losses and cash flow issues

If your business has experienced any of the above symptoms regularly, then it is likely the business is heading toward insolvency. The more rapidly you remedy the situation, the more likely the business is to recover. Don’t put off these issues with hopes that everything will rebound naturally. Use the above tests to check your business’s current status and take the necessary actions. 

Seek Financial Consultation

If you are looking for consultation on your current financial situation, feel free to contact us here at Bartifay Law Offices. We offer several services that can help those who are in deep water, including bankruptcy, foreclosure defense, and mortgage modification. 

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