in this final part 4 of the accounting principles and procedures, we will cover insolvency and credit control. It is something that I am passionate about and hopefully I’ll cover enough from my experience.
Again, this blog is going to cover the accounting principles and procedure RICS competency
What is insolvency?
In a nutshell, insolvency is when your assets don’t cover your liabilities. It’s a term that’s used in finance to describe the financial state of a person or company.
In simple terms, if you owe more than you own, you’re insolvent.
How is it calculated?
The formula for calculating insolvency is: (liabilities – assets) ÷ total liabilities = amount of insolvency. If you’re insolvent, then that number will be greater than zero. If it’s less than zero, then you’re solvent. If it’s positive (meaning your assets are greater than your liabilities), you’re solvent!
What’s the difference between bankruptcy and insolvency?
Bankruptcy and insolvency are similar concepts: both refer to a person or company whose liabilities exceed their assets. However, bankruptcy occurs when this happens over time—you become bankrupt when your debts are too large for you to pay off—whereas insolvency occurs all at once (you become insolvent when your liabilities exceed your assets).
the main difference is that in bankruptcy it is a legal term and will affect your credit score, whereas insolvency is not. Insolvency is reversible if managed and for businesses if it is administered correctly. Bankruptcy it is not reversible it is final state.
as part of engaging my suppliers or taking on a client (mostly business) I check their ability to pay and finance their project. One way of doing this is checking websites like creditfocus or duedil to get data about the business.
It is similar to experian report but open to financial checks on the business. I check how good they are at paying their debt and if they have been late on any payments.
Some red flags are many credit checks against the company, their assets are nil, or if they have a CCJ (county court judgement) for late payment against the company. This is all found on the credit check portal so you don’t have to go dig in different places for them.
If you don’t have this information you can always do a liquidity ratio calculation as shown via this link on google sheet.
The reason why you want to check the credit control of the companies you engage is the ability to get paid or even get your job done.
If you engage a land surveying company that does not have a good credit it may mean that your job might not be done or even insured properly if they go down. It is also good to check if the company has a good working capital. This also allows you to calculate if they can support the project. If you have a survey that is estimated to cost £50k over a period of 1 months or so, and their current working capital is £20k a month they will struggle to cover their expense to produce their job. Ideally the company shouldn’t bid or take on these projects.
For land surveying companies, they can check if the clients they engage with can pay them. This is common in the construction industry for companies to go down under, leaving you out of money. I have had this happen a couple of times even with all the checks, but after 2-3 months, the company went insolvent and couldn’t pay their debts. We now check for the ability for them to pay, if they are high risk we ask for payment upfront.