If a company had an obligation to pay you first but paid another creditor instead, its solvency becomes an issue. Should the incident prompt a lawsuit, you need to look at hiring a solvency expert to conclude if, at the time of the payment, the company was genuinely able to satisfy its long-term interest and repayment obligations.
Experts examine three important solvency points:
- Is there positive equity — meaning, do assets outweigh liabilities?
- Can it pay off debts on schedule?
- Are there sufficient funds to conduct business?
The expert will use that line of questioning to administer three tests to determine solvency::
- Balance sheet.
When the transaction in question occurred, did the subject’s asset value surpass its liability value? Typically, assets are valued at fair market value and not at book value. Fair market value is generally based on historical cost. Fixed assets, like equipment or vehicles, for example, can be reduced by annual depreciation expense. The balance sheet is only the beginning — you might need to make corrections on some line items, adjusting to reflect the assets’ fair market value.
- Cash flow.
Here the expert investigates if the subject incurred more debts than it was able to repay as they came due. This test involves analysis of a series of projections of future financial performance. Experts look at a variety of scenarios, including past performance, current economic conditions, and future prospects. They also consider management’s growth expectations, lower-than-expected growth, and no growth.
- Adequate capital.
The final test ascertains a company’s likelihood of surviving the ordinary course of business while considering reasonable fluctuations hereafter. Experts look beyond the value of net equity and cash flow, taking into account factors such as available credit, debt repayment schedules, and asset volatility.
All or nothing
To be deemed solvent, a company must excel in all three areas of evaluation. Unless a company proves differently, courts will typically consider it insolvent. You can provide objective support for your position with a comprehensive solvency analysis, performed by a credentialed valuation expert. For help moving in the right direction, click here to contact us or call us at 949-860-9902.