COMPANY SOLVENCY CHECK

Understanding whether a business is capable of paying its bills and having a stable future is essential. Our company solvency check can tell you everything you need to know and recommend reliable solutions.

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What is Company Solvency?

Solvency defines a company’s ability to meet its long-term debts and financial obligations. It helps demonstrate the firm’s financial performance and is a key indicator of whether it can manage its operations for the foreseeable future. A firm will be declared solvent if its current assets are worth more than its liabilities.

A company’s assets are items that it owns, such as cash, machinery, property, and inventory. Meanwhile, liabilities are what the business owes. Examples of a firm’s liabilities include utility bills, rent, company taxes, and staff wages. It’s important that a business has not only enough assets to cover its outgoings, but also build a solid foundation in case something unexpected comes along, or to fund future expansion.

It’s important to note that solvency should not be confused with liquidity. While they are both indicators of a company’s financial standing, the two terms are extremely different. Solvency is focused on the long term, while liquidity is about the here and now. Liquidity refers to the firm’s ability to cover its short-term obligations, and how easily it can sell assets to raise cash.

Businesses can therefore technically be insolvent but have high liquidity. This occurs when it has enough cash or easily-disposable assets to cover its short-term outgoings, but the total amount of these assets is worth less than its long-term obligations. Conversely, it’s also possible for a firm to have extremely low liquidity but still be solvent. In this scenario, the company’s assets will more than cover how much it owes, but it is unable to quickly sell them or convert them into cash. Examples of this include unpaid invoices, property, and stock.

For a company to be successful, it must have a good balance between solvency and liquidity, so it’s not only financially robust for the future, but can also weather short-term interruptions should they arise. A firm’s financial position can change rapidly, making it essential to carry out regular reviews to ensure that everything is running smoothly.

Why is Solvency Important?

As a long-term measure of financial stability, company solvency offers an important insight into the health of a business. Should a firm become insolvent, urgent action will be required to turn around its position, otherwise it may need to close down via the process of liquidation.

It’s important that company directors have a clear understanding of how solvent their business is, not only from a stability standpoint, but also for legal reasons. This is because trading while insolvent is an offence and carries harsh penalties — ranging from fines to being disqualified as a director.

Regular company solvency checks can help identify a problem and give business owners as much time as possible to rectify their situation and stay clear of trouble.

Ways to Improve Solvency in a Business

There are several ways in which company solvency can be improved, including:

Reviewing expenses to see if cuts can be made
Offloading unnecessary assets
Avoid taking on new lines of debt
Implement measures to increase sales
Reorganise or restructure your company’s operations
Find ways to increase profitability
Increase owner equity by putting more cash into the business
Issue new shares (for public trading companies)

Not all of these potential solutions may be suitable for your business. This is why it’s a good idea to seek specialist guidance so a tailor-made solution can be found.

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How to Determine a Company’s Solvency

There are several ways to perform a company solvency check, known as solvency ratios. These include the debt-to-equity ratio and the interest coverage ratio. Each of these analyses the ability of a business to satisfy its debts and build for future stability. For some, a higher ratio will be preferred, while others require a low ratio.

Here are the four main solvency ratios in more detail:

Debt-to-Equity Ratio

The debt-to-equity ratio, sometimes known as D/E ratio, compares a company’s total debt relative to its owners total equity in the firm. It illustrates how much of the firm’s net worth is made up of debt, rather than cash or assets, and is used to measure how much of its operations are funded by the money it owes.

D/E ratios are calculated in the following way: Total Liabilities / Total Shareholders’ Equity

A company will typically want its debt-to-asset ratio to be less than 1. Anything higher suggests it has borrowed more money than it’s actually worth, lowering the chances of investors/owners to recoup what they have put into the business.

Debt-to-Assets Ratio

Whereas the debt-to-equity ratio measures a firm’s debt compared to equity, the debt-to-assets ratio takes into account the company’s assets instead. The types of assets used include cash, equipment, and intellectual property. It is another way of measuring how much of a business is funded by debt.

The debt-to-assets ratio is calculated as follows: Total Liabilities / Total Assets

Much like the D/E ratio, a business will want to see a debt-to-assets ratio of below 1. A higher figure suggests that the company has taken on more debt than it’s currently worth. While this is normal for a startup enterprise, it is assumed that the business will be able to grow its assets to the point where they exceed its debts.

Interest Coverage Ratio

This formula measures the number of times a company’s earnings (before interest and taxes, known as EBIT) can be used to pay the interest charges on its debts.

A firm’s interest coverage ratio is calculated as follows: EBIT / Interest Payments

The higher the ratio comes out as, the more solvent the company is and the better chances it has of covering its outgoings. A low ratio suggests that too much of its operating budget is being taken up by interest payments.

Equity Ratio

Particularly useful for investors, the equity ratio examines a company’s total shareholder equity versus its assets. The formula can be used to determine whether the investors have adequately assessed the true value of the business.

The equity ratio is calculated as follows: Total Shareholder Equity / Total Assets

If a high ratio is given, it suggests that the business has been overvalued and is worth much less than what the investors have put into it.

How Inquesta Can Help with a Company Solvency Test

As a licensed insolvency practitioner and business recovery specialist, Inquesta provides an all-encompassing service that is difficult to match. Our team can carry out an independent company solvency check and provide you with an in-depth report about your financial situation.

This report can be particularly useful if you are deemed to be solvent, but later go into an insolvent liquidation, as it can be used to defend your business against claims of wrongful trading. If you are deemed to be trading while insolvent, you could become liable for your company’s debts, so any supporting evidence will prove crucial.

Because we tailor our service to suit our clients, we will also recommend potential solutions to improve your financial position. The sooner you get in touch, the more options will be available to you, so it’s important to reach out at your earliest possible opportunity.

Should your company be unable to continue trading, we can also take care of the liquidation process from start to finish. We have worked with firms from all areas of industry, so we’re perfectly placed to assist. Get in touch with our team today to find out more about how we can help.

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Our Specialist Team

Unsure about your firm’s financial position? Our team can offer an independent company solvency check and offer specialist guidance throughout.

Steven Wiseglass

Director of Insolvency

A co-founder of Inquesta, Steven is a licensed Insolvency Practitioner with over a decade of experience in the field. He is a member of the Insolvency Practitioners Association, Association of Business Recovery Professionals (R3), and his insolvency licence is issued by the Insolvency Practitioners Association. In addition, he sits on the R3 committees of the North West Regional Committee.

Steven specialises in advising directors of small to medium-sized businesses, and has a wealth of expertise in providing the most appropriate advice whatever the firm’s circumstances may be. He has also been instrumental in helping company directors save their business and rebuild them into successful enterprises.

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FAQs

What Should I Do if My Company is Insolvent?

If your company is insolvent, the first thing you should do is cease trading immediately and cancel all present or future contracts. It’s then important to seek specialist assistance from a licensed insolvency practitioner to determine whether your business can be saved.

The sooner you look for help, the more options may be available to you. If you leave it too late, it will become even more likely that your company will need to be liquidated.

What Are My Options if My Company is Insolvent?

Depending on how early you catch the problem, there may be several avenues to explore when it comes to rescuing your firm. These include a company voluntary arrangement (CVA), administration, and business recovery measures. If it ends up being unlikely that your company can be saved, you can close it down via a creditors voluntary liquidation (CVL).

The specialists at Inquesta will carry out a thorough review of your circumstances and recommend what we believe is the most appropriate solution for you.

Do Financial Difficulties Mean I Will Lose My Business?

No. It’s extremely common for businesses — especially small enterprises — to experience financial troubles, and this needn’t spell the end of your firm. Unfortunately, many company directors take action when it’s too late for anything to be done, resulting in the liquidation of their business. This is usually because of a lack of knowledge about their financial position, or a belief that things will get better by themselves.

If you are able to take swift and decisive action as soon as you begin to notice issues with your company’s solvency, you will be much more likely to turn your situation around and save your business.

Do I Need Outside Assistance to Solve My Solvency Problems?

No. It’s entirely possible for you to take a detailed look into your company’s financial position, work out where things are going wrong, and rectify them. The sooner you do this, the greater chance you have of success.

However, business owners may feel that they are too involved with the day-to-day operations of their firm to be able to make a pragmatic and independent assessment of their company. Working with a third party can offer a totally unbiased opinion and recommend solutions based on decades of experience in helping companies in similar situations. This could provide you with a different viewpoint and solutions you may not have thought of yourself.