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The two solvency tests
UK law applies two distinct tests of solvency. The cash-flow test asks whether a company can pay its debts as they fall due — in other words, whether it has sufficient liquidity. The balance-sheet test asks whether the company's total assets exceed its total liabilities, including contingent and future liabilities.
A company can fail one test while passing the other. A business with strong long-term assets but a short-term cash squeeze may be balance-sheet solvent but cash-flow insolvent. Both dimensions matter, and both must be tracked by directors.
Why solvency matters for directors
Directors have a duty under the Companies Act 2006 to consider the interests of creditors when the company is at or approaching insolvency. Continuing to trade while insolvent, with knowledge that there is no reasonable prospect of avoiding an insolvent liquidation, can constitute wrongful trading under the Insolvency Act 1986 — potentially exposing directors to personal liability for company debts.
- Solvency statements are required when a company redeems or buys back its own shares without court order.
- Dividends are only lawful if the company has sufficient distributable reserves and is solvent.
- Banks and lenders may include solvency-related financial covenants in loan agreements.
Monitoring solvency in practice
Regular management accounts, rolling cash-flow forecasts, and debt maturity schedules are the practical tools directors use to monitor solvency on an ongoing basis. If the position is deteriorating, early engagement with advisers is essential — options narrow significantly once formal insolvency becomes inevitable.
Confirm the legal implications of your company's specific solvency position with a qualified insolvency practitioner or legal adviser.
Frequently asked questions
Can a company be profitable and still be insolvent?
Yes. A company generating accounting profit can be cash-flow insolvent if receivables are slow to convert to cash while creditors demand payment. This is particularly common in fast-growing businesses where working capital outpaces receipts.
What is a solvency statement?
A statutory declaration by directors that the company will be able to pay its debts as they fall due for the twelve months following a specific transaction — most commonly used in share buybacks or capital reductions without a court order.
Funding for UK limited companies
Credicorp lends to your company, not to you personally — short-term working capital with no personal guarantee. See what your business could access.