Business Debt Problems: Warning Signs and What to Do

Early warning signs

Owners usually know something is wrong before they admit it. These patterns are worth taking seriously as soon as they appear, because each one is easier to fix early.

• Paying one creditor with another. A new card, loan or advance is used to make a payment on an existing one. The total owed rises while the problem that caused it stays unsolved.
• Relying on the overdraft at month end. An overdraft that is used every month, and never fully repaid, has become a loan with no end date and a higher cost than most term borrowing. See business overdraft debt.
• HMRC arrears building. VAT or PAYE is paid late once, then regularly, then not at all. Because HMRC does not chase in the first few weeks, this debt grows quietly and attracts interest and penalties.
• Directors' loans propping up cash. Owners put personal money in to cover wages or suppliers. This can be sensible as a bridge, but it is a warning sign if it has become routine.
• Late supplier payments. Suppliers are paid in the order they shout, credit limits are cut, and deliveries start to require payment up front, which worsens cash flow further.
• No forecast. The owner cannot say with confidence what the bank balance will be in six weeks. Decisions are made day to day.

The insolvency tests in plain words

Insolvency is a legal state, not a feeling. Two tests are used for companies, and the same ideas apply in practice to sole traders.

The cash-flow test

A business is cash-flow insolvent if it cannot pay its debts as they fall due. It does not matter how much it owns or how profitable it expects to be next year. If the VAT is due on Friday and the money is not there, with no realistic way to get it, the test is failed on that day.

The balance-sheet test

A business is balance-sheet insolvent if its liabilities, including those that may arise in future, exceed its assets. A company can pass the cash-flow test and fail this one, for example where it is kept going by an overdraft but owes more than it could ever raise by selling everything.

Why the tests matter for directors

Once a director knows, or ought to know, that the company cannot avoid insolvent liquidation or administration, their duty shifts from the shareholders to the creditors as a whole. Continuing to trade and increase losses, paying some creditors ahead of others for personal reasons, or taking on debt the company cannot repay can lead to personal liability or disqualification. This is why early, documented decisions and professional input matter. Finance Business Debt does not give insolvency advice; a licensed insolvency practitioner or Business Debtline can explain where you stand.

Prioritising creditors when there is not enough cash

No business should plan to leave anyone unpaid, and in a formal insolvency the law sets the order. But in a tight month, most businesses have to decide who is paid first. The usual order of attention is:

1. Secured lenders. A lender with a charge over property, vehicles or equipment can take the asset if payments stop. If the business cannot trade without the asset, this payment protects everything else.
2. Preferential creditors. Employees' wages and holiday pay, and certain HMRC debts such as VAT and PAYE, rank ahead of ordinary creditors in an insolvency. Unpaid wages also stop the business operating.
3. HMRC. HMRC can agree a Time to Pay arrangement if contacted early, and can use enforcement powers if not. Our HMRC tax debt page explains the process.
4. Suppliers critical to trading. The supplier without whom the business cannot deliver its product deserves a candid conversation and a realistic payment plan before less critical suppliers.
5. Unsecured lenders and other creditors. These should not be ignored, and a lender can still take action, but a missed payment here is usually less immediately damaging than losing a secured asset or a key supplier. See business loan arrears.

Paying creditors in a deliberate order, recorded in writing with reasons, is very different from paying whoever shouts loudest. If the business is insolvent, choosing to pay a connected party or a creditor you have guaranteed personally ahead of others can be challenged later.

What to do this week

• Write down every debt, including HMRC, suppliers, directors' loans and any personal guarantees.
• Build a 13-week cash-flow forecast, week by week, using realistic receipts rather than hoped-for ones.
• Contact HMRC through GOV.UK before a payment is missed if tax cannot be paid on time.
• Speak to lenders and key suppliers before the payment date, not after.
• Stop any new borrowing until you know whether the business can afford what it already has.
• Call Business Debtline, or a licensed insolvency practitioner if the forecast shows the gap does not close.

Where consolidation or refinancing may fit

If the forecast shows the business makes enough cash over a year but the repayments are badly timed or expensive, restructuring the borrowing can be the answer. Business debt consolidation replaces several facilities with one, which can lower the monthly outgoing, usually by extending the term and therefore increasing the total repaid. Refinancing replaces a single costly facility on better terms. Both depend on affordability, credit history and, for most limited companies, a personal guarantee.

They will not fit where the business is already in arrears with several creditors, is loss-making, or fails either insolvency test. Providers are unlikely to approve new borrowing in those circumstances, and if they do, it tends to make the eventual position worse. Business debt restructuring, which changes the terms of existing debts by agreement, or a formal procedure may be more realistic.

Frequently asked questions