Is my client insolvent?

A person is solvent, if and only if, the person is able to pay all the person’s debts, as and when they become due and payable


Is my client insolvent?

With the constant talk in the media about recessions, fiscal cliffs, the end of the Government’s JobKeeper stimulus, zombie companies and pending insolvencies, here at Clout Advisory, we thought that the question that people will inevitably start asking…

What does insolvency mean?

Section 95A of the Corporations Act 2001 defines insolvency as “a person who is not solvent is insolvent”. Yes, this does little to illuminate the subject.

The legislation does elaborate a little with “a person is solvent, if and only if, the person is able to pay all the person’s debts, as and when they become due and payable”. There is a timing issue flagged here.

So, just because a company or person has positive net assets shown on the balance sheet, it does not necessarily mean they are solvent. Given the timing question, it means that solvency is a cash flow test, not a balance sheet test!

As you can appreciate, this means there are many aspects to consider if you are asked. This edition of News with Clout provides a rough guide on this sticky and potentially dangerous question.

As timing is a crucial issue, from an insolvency practitioner’s point of view, these are some of the problems we consider.

  1. What does the working capital position look like?
  2. Is the working capital figure meaningful?
  3. Would the quick asset ratio be more relevant for that business or industry?
  4. Is there an overdraft in the working capital calculation?
  5. Are the current liabilities due imminently or not till or towards the end of twelve months?
  6. What is the overdraft limit?
  7. What is the net asset position?
  8. Are there any loan accounts due to owners which will not be called up?
  9. Are there any assets in the net asset position with no real value?
  10. Is the company making a profit?
  11. What is the profit trend?
  12. Is the company making a cash flow profit?
  13. Are the provisions adequate?
  14. Are there surplus assets that can be sold?
  15. Can the company offer sufficient security to borrow money from its position?

Although this is not an exhaustive list, once you can put the answer to these questions, it will provide both the adviser and client with some clarity on the solvency of the company.

Naturally, the earlier a looming insolvent position can be ascertained, the more proactive and viable options will be available to the client, such as a workout, turnaround, or restructuring. And most importantly, the greater chance of success! Note that with the new restructuring legislation, there is much more incentive for people to move quickly.

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