What is the balance sheet test for insolvency?

The balance sheet test determines whether a company’s total liabilities exceed its total assets. This test is one of the two primary ways UK law identifies insolvency. Assets include property, cash, stock, receivables, and other resources with value. Liabilities include loans, tax arrears, trade debts, and contingent liabilities such as legal claims or guarantees. If liabilities outweigh assets, the company is insolvent on a balance sheet basis, even if it currently has cash to meet short-term debts. This situation often arises when businesses are overleveraged, for example holding large long-term loans that exceed the value of their assets. Directors should be cautious, as a balance sheet insolvency may not immediately affect day-to-day operations but can have serious implications if creditors enforce debts. Insolvency practitioners often use this test in combination with the cashflow test to form a clear picture of a company’s financial health.