What You Need To Know
Before embarking on a turnaround, it is vital to investigate your current financial position. You need to consider the following questions:
- How did I get here? What has the recent trading performance been like and what are the trends?
- Where am I now? Are you insolvent or not? What cash do you require in the short term? To what degree can you rely on the bank for support?
- Where am I going? What are the longer-term cash, profit and loss, balance sheet and security forecasts?
If you are in a cash crisis, you have to focus on the second point before addressing the past or future so as to ensure your immediate or short-term survival.
Understanding your past financial performance is covered in Chapter 7. Short-term forecasts (which you need to prepare to obtain the proper advice on continuing to trade and to assess the immediate cash requirements and the likelihood of bank support) can be rolled forward later for use in longer-term planning.
All the workings and examples in this chapter assume you are a director of:
- a limited liability company incorporated in England and Wales
- with a number of employees
- that is registered for VAT and
- has an overdraft for which the bank has taken security by way of a valid standard UK bank debenture covering any debt due (an ‘all-monies charge’).
The key questions in a cash crisis are as follows:
Insolvency
In principle, insolvency simply means the company is unable to pay its debts as they fall due. Where a winding-up is sought on these grounds, the Insolvency Act 1986 sets out four tests, failure of any of which is taken to prove insolvency:
Therefore both the short-term cashflow forecast and the revised balance sheet used to check the security position (covered in this chapter) are the tools you need to check the last two tests.
Insolvency matters because, if the company fails, a liquidator can potentially act to set aside some transactions made when the company was insolvent and hold you personally liable for the company’s losses (see Chapter 11). Additionally, your responsibility for the insolvency will be taken into account when considering company director disqualification proceedings (see Chapter 11).
If you are not trading through a company but are acting as a sole trader, however, you have unlimited liability for all your own debts (business and personal). If you are trading in a partnership, all the partners are liable together and individually for the partnership’s business liabilities (’jointly and severally’) unless it is a Limited Liability Partnership (’LLP’). The moral is, when in doubt, if you are concerned about solvency, you should seek professional advice.
Example
Companies D and E’s balance sheets with assets stated at book value are set out below:
No overdraft facilities have been negotiated.
Company D is clearly insolvent on a balance sheet test in that its liabilities exceed its assets. Worse still, in winding up a company, the ‘going concern’ basis of accounting no longer applies. This means that:
- Assets will be restated at realisable values (i.e. what they can realistically be sold for) rather than at their normal book values. Where property has been carried in the books at its cost 25 years ago, this can be good news. More often, however, it means bad news in respect of debts, stock and work in progress, which have to be written down as what will actually be recovered.
- Liabilities must include contingent liabilities (e.g. redundancy payments to employees) that will fall due for payment (‘crystallise’) on failure of the company and are therefore generally higher than shown in the books.
When it comes to preparing an insolvency statement of affairs, Company D may therefore find its position is worse than it looks here on book values.
If all Company E’s trade creditors are now due for payment it is insolvent on a cashflow basis as it does not have the cash to hand with which to pay these debts. Whilst it has surplus assets, its cash is largely tied up in property – an illiquid asset.