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What you NEED to know about solvency and liquidity tests

by , 31 January 2014
You're required to do solvency and liquidity tests. This is a legal requirement by the Companies Act. Continue reading as we tell you everything you need to know about solvency and liquidity tests.

Solvency and liquidity tests are compulsory.

Why?

This is to ensure your company is cash healthy before and after making certain transactions.

You'll be required to do solvency and liquidity tests when doing the following the following activities:

  • Provide financial assistance to people so they can buy your company's shares
  • Makes loans to directors
  • Declares a dividend

That's not all.

You'll also have to do a liquidity test when there's a merger.

The solvency and liquidity test will help determine whether or not your company's liquid.

What does liquidity mean?

Your company's liquid if it can pay its debts when they're due.

You'll have to do a cash flow forecast to see if your company's liquid.

The Practical Accountancy Loose Leaf defines a cash flow forecast as an estimate of the timing and amounts of cash inflows and outflows over a specific period (usually one year).

A cash flow forecast will show you, for instance, if you need to borrow any money, how much you need to borrow and when and how you'll repay the loan.

The Small Business Development Corporation says by including every case scenario in your cash flow forecast you'll see how your business will cope if it hits tough times or does better than expected.

'Prior warning allows you to work out solutions to anticipated temporary cash shortfalls or arrange short-term investments for temporary cash flow surpluses.'

Now that we've told you about solvency and liquidity tests, use these three tips to ensure your solvency and liquidity tests are accurate.

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