Insolvency and cashflow forecasts

Use this page to understand what insolvency means and how to recognise it.

There’s no legal definition of insolvency, but in practice, there are two tests, either of which might show insolvency:

• The cashflow test: An organisation is unable to pay its debts as they become due.
• The balance sheet test: The value of an organisation's assets is less than the value of its liabilities (overall, it owns less than it owes to other people).

When assessing the two tests set out above, you need to get accurate and timely financial management information.

You’ll need to be familiar with this information and be able to spot whether issues are ‘one-off’ or signs of problems to come or trends. The finances should mirror what you know and what’s reported about the activities of the organisation.

Signs to look out for are patterns of:

• running repeated deficit budgets
• reducing bank balances and reduction of cash on the balance sheet
• increase in amounts owing to suppliers
• late payments to HMRC, increase in amounts owing to grant funders (or other debts)
• increased costs compared with budget
• decreased income compared with the budget.

Any of these might show that you need to take some action. Sometimes, with a good cashflow forecast, we can see these issues come up and take corrective action in good time to avoid them.

A lack of immediate cash to pay debts most often causes organisational challenges. Developing a cash flow forecast will help you see when you may have a lower income and how to handle this.

A cash flow forecast can be developed by mapping out on a month by month, or week-by-week basis:

1. The payments the charity will have to make over a set timeframe (typically 6-12 months)
2. the cash currently available to the charity to cover those payments
3. the income the charity expects to receive over the same timeframe along with an assessment of how likely and secure the income is.

Read our guidance on cashflow forecasts.

NCVO worked with Liz Pepler at Embrace Finance to create this guidance.