Cash Flow & Balance Sheet Insolvency – What’s The Difference?
If a company is ‘insolvent’ this means that they are unable to pay their debts as they fall due. There are however two different types of insolvency that it’s important for companies to be aware of. These are cash flow and balance sheet insolvency. There’s take a look at what each of these involve and how they’re identified in order to determine the main differences between cash flow and balance sheet insolvency.
What is cash flow insolvency?
Cash flow insolvency occurs when a company cannot meet demand for payments as and when they fall due. The company might have enough assets to pay, but not the appropriate form of payment, i.e. cash, to make the payment successfully. They may be unable to sell the assets or raise cash against them quickly enough. In this sense, a company that is facing an issue with cash flow insolvency may be asset rich but cash poor, although this is not always the case. In many instances, the company will also not have enough assets to pay their debts.
What is balance sheet insolvency?
Balance sheet insolvency occurs when a company’s liabilities outweigh its assets, preventing them from paying their debts as they fall due. This also takes into account contingent and prospective liabilities, such as deferred payments.
What is the balance sheet insolvency test?
The balance sheet test is used to determine if a company has greater assets than liabilities or vice versa. The test takes into account all the company’s assets in detail and places them against all of the company’s debts, including contingent and prospective liabilities. Should this comparison show that the company has more debts than assets, this means they are technically insolvent and should consider the best options available to them with the help of an insolvency professional. Options that the company may have could be voluntary liquidation or a business rescue plan.
When looking at the difference between cash flow and balance sheet insolvency, it’s important to note that balance sheet insolvency is easier to test for than cash flow insolvency. A cash flow test can be used to identify if a company cannot pay its debts as they fall due or in the ‘reasonably near future’. This time period is not specific, meaning that the test becomes more speculative than accurate. However, assessing a company’s finances in this way can help to identify where the company is struggling to meet day-to-day costs, allowing them to act on this and prevent the problem from spiralling.
The difference between cash flow and balance sheet insolvency
Cash flow and balance sheet insolvency are both issues that prevent a business from being unable to pay its debts. However, as the names suggest, balance sheet insolvency is concerned with assets vs liabilities, whereas cash flow insolvency is convened with, well, cash flow vs liabilities.
When a company is facing cash flow problems, they may have enough assets to pay their debts, but lack the capacity to liquidate cash from those assets in order to make payments on time. If a company is facing balance sheet insolvency however, they do not have enough assets to pay their debts. This type of insolvency is more difficult to rectify, highlighting another crucial difference between cash flow and balance sheet insolvency.
If you are concerned that your company might be facing insolvency, it’s important to act as early as possible. This will provide you with more options for recovering or liquidating your business in the most profitable way. Don’t hesitate to get in touch with our experienced team of licensed insolvency professionals today for confidential advice.