It is almost impossible for a company to totally avoid debts; in fact it is usually seen as an important part of financing a business. However, most of us make the mistake of thinking all debts are bad. This is wrong because there are debts, and then there are bad debts. How can debts be bad? Debts become bad when the amount you have borrowed becomes overwhelming to the point where cash flow issues arise. Not just debts can cause cash flow problems, a number of other factors could lead to this, but when these factors become consistent, it can lead to a serious issue. Also, we often confuse the term “insolvency” and “bankruptcy” as meaning the same thing. First of all, we will explain the difference between these two terms, and how best to identify them and properly avoid them.
Insolvency and Bankruptcy
Insolvency is a term used by financiers to describe the situation of a company when this company is unable to pay its own debts. It means the company is unable to pay bills when due, and it has more liabilities than assets. As a limited company, experts have adviced that trading should stop the moment the company begins tilting towards insolvency. Also, it is against the law and is called Wrongful Trading. This is a situation whereby the company continues trading in the event of an insolvency in spite of the damaging effects it will have on creditors. This is defined in the Insolvency Act of 1986.
When the authorities find out about this, and Wrongful Trading is proved, henceforth the directors will be responsible for the debts of the company from the moment they knew about the insolvency status of the company. Another term that exists in Fraudulent Trading, and this refers to a situation whereby directors continue trading while having no intent to repay debts.
Bankruptcy on the other hand is when a company makes a legal declaration of its inability to repay debts. Naturally, bankruptcy can be a solution to insolvency. There’s another term that is closely related with these terms, and it is Liquidation. Liquidation occurs when a business pays off its debts by selling off its business assets after being audited.
After a year (sometimes more) of applying for bankruptcy, the debts of a company are written off. A company can apply for bankruptcy, or a private individual, even a creditor can do so on your behalf. But before you can apply, you must owe at least £5,000 or more. The petition for a bankruptcy gives the court a right to take your assets and sell it to pay your debts.
Now, let’s circle back to the subject, how can my business survive being insolvency? First of all, you should know that insolvency is not the end of the world, or even the end of your business. Your biggest motivation should be not to enter liquidation, because that is the point of no return.
Here are a few things you could do:
1. Speak with all creditors and see if you can secure an agreement off the books: This means you should try to secure an informal agreement that states that the debt will be paid on an agreed date, this could be full or part payment. This works even better when you are going through a temporary financial problem.
2. Hand the company over to an administrator: Be rest assured that this does not mean selling your company, or choosing to be liquidated. What it means is handing your company over to the hands of an insolvency practitioner or an administrator. The job of this administrator will be to help you manage your company’s debts and even find a way to prevent liquidation. Most times, these experts try to pay your debts from your assets.
Now that we have identified how to tackle insolvency when it rears its ugly head, it is important that we also discuss ways you can avoid bad debts in the first place. There are several precautions you can take to prevent your company from having a bad debt (which is a kind of debt that you are incapable of paying to your creditor and vice versa.
According to a survey conducted by Reporting Accounts with 100 businesses. It was discovered that 68% of these businesses have had a late payment issue, while another 53% have been in a position where they had to write off a bad debt.
Also, a great way to prevent an issue of a bad debt is to run a comprehensive background check of companies before you work with them. The most important is the credit check which companies can also use to check their own business, and see how healthy its finances are. Credit reports provide you with comprehensive and detailed information filled with graphs and reports of assets and liabilities over a period of them. You can also check your Credit Risk Score which is a score that tells you the likeliness of your company becoming insolvent in the next one year.
Checking your credit report can also be used to discover potential customers. A credit report also gives you the general “health status” of your business. It tells you how much debt the company is in, and how much the company is making in terms of profit, plus the company’s level of liabilities in comparison to assets. Whatever these reports suggest to you, it is important that you take steps on it.