There are two separate legal tests for company insolvency in the UK: the cashflow test and the balance sheet test. A company is insolvent if it fails either test, even if it comfortably passes the other. Understanding balance sheet vs cashflow insolvency matters because a company can look financially sound on paper yet still run out of cash — or hold healthy cash balances while its overall liabilities quietly outweigh its assets.
Many directors assume insolvency simply means "no money left in the bank." In UK law it is broader than that, set out in section 123 of the Insolvency Act 1986. Knowing which test your company might meet helps you understand your position — and your legal duties as a director — more clearly.
Why there are two tests for insolvency
UK insolvency law recognises that a company's finances can break down in two different ways. One is a timing problem: the company has debts due now but not enough cash to pay them. The other is a structural problem: added up, the company owes more than it owns.
Section 123 of the Insolvency Act 1986 sets out both tests. A company is deemed unable to pay its debts if it fails the cashflow test or the balance sheet test — the law does not require both to be met. This is why balance sheet vs cashflow insolvency is worth understanding separately, rather than as one single idea of "being insolvent." For a fuller walkthrough of both tests, see Is My Company Insolvent? The Two Legal Tests.
The cashflow test: can you pay debts as they fall due?
The cashflow test asks a simple, practical question: can the company pay its debts as and when they become due? If creditors, HMRC, staff or suppliers are owed money that is due now, and the company cannot pay it, the cashflow test is failed — regardless of what the balance sheet shows.
Common signs a company may be approaching cashflow insolvency include:
- Repeatedly missing supplier payment dates or negotiating extended terms
- Falling behind on PAYE, VAT or corporation tax owed to HMRC
- Relying on new borrowing or director funds just to cover day-to-day bills
- Receiving statutory demands or county court judgments for unpaid debts
A company under sustained pressure like this is often described as facing a cashflow crisis. If this sounds familiar, Business Cashflow Crisis: How to Take Control looks at the practical steps directors can take early on.
The balance sheet test: do liabilities exceed assets?
The balance sheet test looks past the day-to-day and asks a wider question: if you added up everything the company owes, including future and contingent liabilities, would it exceed everything the company owns? If so, the company is balance sheet insolvent, even if it is currently paying its bills on time.
This test takes into account:
- Current assets, such as cash, stock and money owed to the company
- Fixed assets, such as property, equipment and long-term investments
- All liabilities, including loans, leases, and money that may become due in future
Valuing assets fairly and including realistic future liabilities is where this test gets harder to apply than it first sounds — which is one reason directors often seek a specialist's view rather than guessing.
How a company can fail one test but not the other
A company can be asset-rich but cash-poor: it owns valuable property or equipment, so its balance sheet looks strong, yet it cannot convert that value into cash quickly enough to pay a pressing debt. This company fails the cashflow test but may pass the balance sheet test.
The reverse is also possible. A company might be meeting all its payments on time — passing the cashflow test — while quietly building up liabilities, such as pension obligations or long-term leases, that outweigh its total assets. That company is balance sheet insolvent despite appearing to manage day-to-day.
This is the core of balance sheet vs cashflow insolvency: they measure different things, over different timeframes, and a company only needs to fail one to be legally insolvent.
Why both matter for a director's duties
Once a company is insolvent, or approaching insolvency, a director's legal duty shifts. Directors must start prioritising the interests of creditors as a whole, not just shareholders. Continuing to trade and take on new credit while knowing (or where you ought to have known) the company could not meet its debts can expose a director to personal risk.
This applies whichever test the company fails. A director cannot rely on "we're still paying our bills" as a defence if the balance sheet test shows liabilities exceed assets, and vice versa. For a closer look at the risks this creates, see Trading While Insolvent: Risks for Directors.
What to do if your company meets either test
If you think your company may fail the cashflow test, the balance sheet test, or both, the earlier you act, the more options are usually available. Useful first steps include:
- Get an up-to-date, honest picture of cash position and forward liabilities
- List all creditors, including HMRC, and note which payments are overdue or at risk
- Avoid taking on new credit or debt you cannot be confident of repaying
- Speak to a regulated insolvency practitioner or solicitor before the position worsens
Directors do not need to have all the answers before reaching out. A regulated specialist can assess which test applies, if either, and set out the realistic options — from restructuring to formal insolvency processes.
Frequently asked questions
What are contingent liabilities and do they count in the balance sheet test?
A contingent liability is a debt that only becomes payable if a future event happens, such as a guarantee being called in. The balance sheet test does take these into account, which is why a company can look solvent on a simple asset list but still fail the test once contingent liabilities are properly included.
How do I value assets for the balance sheet test?
Assets should generally be valued realistically, at what they could reasonably achieve, rather than at cost or book value. Property, stock and equipment can be worth significantly less in a forced or urgent sale than their listed value, which is a common reason companies overestimate their solvency.
Do director loans affect either insolvency test?
Yes. Money owed to the company by a director is an asset for the balance sheet test, while money the company owes to a director is a liability. Either can shift the outcome of the test, so director loan accounts are usually reviewed closely as part of any insolvency assessment.
Can a profitable company still be insolvent?
Yes. Profit on paper does not guarantee cash in the bank, and a company can be profitable yet still fail the cashflow test if money is tied up in unpaid invoices, stock or long payment terms. This is one of the more counter-intuitive aspects of balance sheet vs cashflow insolvency.
Which test do courts use most often?
Courts can rely on either test, and creditors petitioning to wind up a company can point to whichever applies. In practice, the cashflow test is used more often because it is easier to evidence — an unpaid, undisputed debt that is due and demanded is straightforward proof.
This article is general information, not legal, financial or insolvency advice, and does not consider your company's specific circumstances. Directors should speak to a regulated specialist about their own position before making decisions.
If you would like to understand where your company stands, Harbourfirst can introduce you to a regulated insolvency practitioner or solicitor for a clear, no-pressure conversation — start an enquiry.