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What is solvency?

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What is solvency?

During periods when demand for your goods and services drop – for example, if your business has been closed down or adversely affected by the recent COVID-19 outbreak – your sales and incoming cash receipts tend to drop at a faster rate than you are able to reduce your outgoings.

Expenses tend to fall into one of two groups:

  • Those that tend to vary in direct proportion to your sales: buying raw material or stock for resale, or
  • Fixed overheads: rents, rates, wages, and other recurring costs.

Variable costs can be reduced quickly once a downward sales trend is confirmed. Fixed costs can also be reduced but over a longer time period.

During a time when costs overtake income, losses occur. If losses are significant they may exhaust any reserves you have built up in your business. When this happens, you are in danger of becoming insolvent (liabilities exceeding assets).

Consequently, if your business is experiencing a downturn, keeping your accounts up-to-date is of paramount importance. Most accounting software will produce a balance sheet and we can show you how to monitor this report to warn you of approaching insolvency.

Please call if you need help to organise your record keeping and we will provide you with the information you will need. 

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