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How to Recognize Insolvency

In a legal sense, insolvency is discussed in section 95A(1) of the Corporations Law. A company is insolvent if it cannot pay its debts as and when they fall due. There is a great deal of case law which attempts to analyse this proposition. The simplest test is to ask whether it is reasonable to expect that problems can be overcome. If the answer to this question is, no! Then the company is probably insolvent.

Some other principles have been set down in case law in discussions of the definition of insolvency:

* it is not a balance sheet test, however, a deficiency of assets will be indicative but not decisive in determining insolvency;
* cash on hand is not a requirement to determine solvency;
* both cash reserves and the ability to raise funds are relevant;
* a temporary lack of liquidity does not necessarily mean insolvency;
* it is not appropriate to consider that forbearance indicates that a debt is not payable.

Listed below are some indicators of insolvency:

* Statutory creditors not paid on time
* Trade creditors being paid beyond agreed terms
* Payment arrangements entered into with creditors and payments made in round amounts
* Overdraft limit being exceeded
* Non-compliance with the terms of a loan
* Cheques returned unpaid from a bank
* Suppliers cease to supply or require payments on a COD basis.
* Accounting records in disarray
* Legal actions by creditors
* Deficiency in working capital
* Deficiency of total assets on the balance sheet