Balance-sheet insolvency is a legal test used to determine whether a company is insolvent. It applies when the total value of your liabilities outweighs the realistic value of your assets.
Even if your company can still pay its bills today, it may still be classed as insolvent if its balance sheet is upside down. Because of that, balance-sheet insolvency can catch directors off guard. It isn’t always obvious until you look closely at asset values, loan balances, tax arrears and contingent liabilities.
What balance-sheet insolvency means
This test looks at the overall financial position of the company, not its daily cash movements. The question is simple: if you sold everything the company owns at realistic market value, would you have enough to repay all creditors?
You may be balance-sheet insolvent if:
- Loans, tax arrears and trade debts exceed the value of all assets
- Stock or equipment is worth much less than its book value
- The business holds slow-paying or bad debts that won’t be recovered
- You have contingent liabilities such as guarantees or warranty claims
- Overdrawn directors’ loan accounts can’t be repaid
Many directors overestimate the value of assets because accounts show historic figures rather than what could actually be realised. Insolvency practitioners use conservative valuations, reflecting what assets would sell for in the real world.
How to check whether your company is balance-sheet insolvent
A practical check includes:
- Listing all assets, such as cash, stock, equipment, vehicles, intellectual property and money owed to you
- Valuing them realistically at what they would sell for, not what you bought them for
- Listing all liabilities, like bank loans, Bounce Back Loans, HMRC arrears, supplier debts, rent, wages and contingent liabilities
- Comparing the totals, so if liabilities outweigh assets the business is balance-sheet insolvent
Directors often find the picture changes dramatically once assets are valued fairly. For example, slow-moving stock or older equipment may not cover what the accounts suggest.
When balance-sheet insolvency matters
Once insolvency is confirmed, your director’s duties shift. You must protect the interests of creditors rather than shareholders. If you continue to trade without taking advice, you risk accusations of wrongful trading if losses increase any further.
Balance-sheet insolvency also affects decisions like dividends. Paying dividends when there are no profits can cause personal liability claims later.
How balance-sheet insolvency links to cash-flow insolvency
Balance-sheet insolvency often follows cash-flow pressure. As arrears grow, liabilities rise and assets may lose value. Eventually the company may fail both tests.
Some companies, however, fail the balance-sheet test first. For example, a business may receive a large claim or face a significant warranty cost that suddenly turns the balance sheet negative while cash still flows day to day.
Understanding both tests helps you decide whether the business can be rescued or whether closure is the safer route.
What options you have if your balance sheet is negative
A negative balance sheet doesn’t always mean immediate closure. Your options include:
Company Voluntary Arrangement (CVA)
If the business is viable, a Company Voluntary Arrangement restructures debt into an affordable payment plan across all unsecured creditors.
Administration
Administration gives breathing space through a statutory moratorium, allowing an insolvency practitioner to look for a restructure or sale.
Creditors’ Voluntary Liquidation (CVL)
If recovery isn’t realistic, a Creditors’ Voluntary Liquidation is often the safest route. It closes the business properly, ensures creditors are treated fairly and protects directors who acted responsibly.
Negotiating with creditors
In some cases, debts can be reduced or deferred through negotiation, though this is only likely to be viable if the business still has a clear future path and you have a good relationship with them.
Key takeaways: What is balance-sheet insolvency?
- Balance-sheet insolvency means liabilities exceed assets
- It’s one of the two legal tests for insolvency
- Asset values must be realistic, not optimistic
- Once insolvent, director duties shift towards creditor interests
- Rescue options exist if the business has potential, and liquidation is appropriate if it doesn’t
Get advice on balance-sheet insolvency
If your liabilities are starting to outweigh your assets, or you suspect they might, the key is to get a clear assessment before decisions are forced on you.
Our qualified insolvency practitioners can review your figures, stress-test asset values and confirm whether you’re technically insolvent. From there, we’ll outline all the realistic routes forward, whether that’s restructuring, negotiating with creditors, or closing the company through a formal process that protects you from personal risk.
A conversation at this stage gives you more control and avoids the dangers of letting matters drift. Speak to us for free, confidential guidance tailored to your company’s situation.
