Last Updated: 12/08/2026
What is insolvency?
Insolvency is where you or your business cannot afford to pay your debts either in full or on time. In legal terms, a company is insolvent when it cannot pay its debts as they fall due, or when its liabilities are greater than its assets and a formal insolvency process is probable. Insolvency is a financial condition. It is separate from the formal procedures, such as liquidation or administration, that an insolvent company might then enter.
What are the two tests of insolvency?
There are two tests of insolvency: the cash-flow test and the balance-sheet test. The cash-flow test asks whether a company can pay its debts as they fall due. The balance-sheet test asks whether its liabilities are greater than its assets. A company only needs to fail one of these tests to be regarded as insolvent, and many companies fail the cash-flow test first.
The cash-flow test
The cash-flow test looks at whether a company can meet its bills as they become due for payment. Persistent late payment, pressure from suppliers and HM Revenue and Customs, and county court judgments are all signs that a company may be failing this test. It is the more common of the two, and a company can fail it while still appearing to own more than it owes on paper.
The balance-sheet test
The balance-sheet test compares what a company owes with what it owns, including liabilities that are contingent or prospective. The simplest way to check is to look at your most recent balance sheet, which is a snapshot of your assets and liabilities. If the total at the foot of the balance sheet is shown in brackets, meaning a minus figure, then liabilities exceed assets and the company is balance-sheet insolvent.
Insolvency vs liquidation vs bankruptcy: what is the difference?
These three terms are often used interchangeably, but they mean different things. Insolvency is the financial state of being unable to pay your debts. Liquidation is a formal process a company goes through to stop trading, sell its assets and close. Bankruptcy is the personal insolvency process that applies to individuals, not to companies.
In practice, a company becomes insolvent first. It may be able to trade out of insolvency or may then be placed into liquidation or another procedure. A person, rather than a company, is the one who can be made bankrupt. So a limited company is never made bankrupt in the strict legal sense, even though the word is often used loosely to describe any business failure.
What does insolvency mean for a limited company?
For a limited company, insolvency changes whose interests the directors must put first. Once a company approaches insolvency, or likely to become insolvent, directors’ duties shift increasingly towards protecting creditors as a whole rather than shareholders. Insolvency does not automatically close a company. Depending on the circumstances, the routes available can include negotiating with creditors, a company voluntary arrangement, company administration, or a creditors’ voluntary liquidation.
The right route depends entirely on the specific facts of a company’s position. For directors who need the next step, our Director’s Guide to Company Insolvency explains what to do when a company is insolvent and how each option works.
This page is general information, not advice about your own situation. A specific company’s position should always be checked with a licensed insolvency practitioner.
Insolvency FAQs
Is insolvency the same as bankruptcy?
No. Bankruptcy is the formal insolvency process for individuals, not companies. An insolvent company is wound up through liquidation or enters another procedure such as administration, and it is never made bankrupt in the legal sense. The term bankruptcy is often used loosely to mean any insolvency, but in UK law it applies only to people.
Can an insolvent company keep trading?
An insolvent company can sometimes continue to trade, but it is a point of real risk for its directors. Once a company is insolvent, or likely to be, directors must act in the interests of creditors, and trading on in a way that worsens the creditors’ position can lead to personal liability. Taking advice from a licensed insolvency practitioner before deciding whether to continue is the safer course.
What is the difference between insolvency and liquidation?
Insolvency is a financial state: being unable to pay debts as they fall due, or owing more than you own. Liquidation is one of the formal processes that can follow, in which a company stops trading, its assets are realised and it is closed. A company can be insolvent without being in liquidation, and a solvent company can also be liquidated, for example through a members’ voluntary liquidation.
Speak to a licensed insolvency practitioner
If you are concerned that your company may be insolvent, we offer free initial advice with a licensed insolvency practitioner. There is no charge for that first conversation, and charges only apply if and when terms of engagement are agreed. Meetings can be held at our office or your premises and are completely confidential. Call 0800 331 7417 or book free initial advice.
How can we help - Book a free 1-2-1
If your company is struggling with unmanageable debts, decreased cashflow or concerns about about your company’s future, we can assess your situation and provide you with tailored solutions and options.
During your free initial advice meeting, we will discover a true picture of your company’s financial situation
and offer practical and expert guidance on your next steps.
Initial meetings can be held at our office or your premises and are completely confidential.
There is no charge for this meeting – charges only apply if and when terms of engagement have been agreed.
