Company Solvency Test Calculator

This calculator applies the solvency test that New Zealand company directors must satisfy before authorising any distribution, which includes a dividend, a share buy-back and certain other payments to shareholders. The test in section 4 of the Companies Act 1993 has two separate limbs and both must be met. The first is a liquidity question: can the company pay its debts as they become due in the normal course of business? The second is a balance sheet question: is the value of the company's assets greater than the value of its liabilities, and critically, that includes contingent liabilities such as guarantees, lease commitments and disputed claims. Because they measure different things, a company can pass one and fail the other, and the most common trap is a business with plenty of assets and not enough cash. The calculator tests each limb separately, shows the headroom in dollars rather than a bare pass or fail, then re-runs both after a proposed distribution so you can see whether the payment would still leave the company solvent. It also shows the largest distribution that would keep both limbs satisfied. This is a planning aid to structure the question properly, not a substitute for the judgement directors are personally accountable for, and it is not legal advice.

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Two Limbs, Both Compulsory

The New Zealand solvency test is not a single measure with a threshold. Section 4 of the Companies Act 1993 sets two distinct questions and a company satisfies the test only if the answer to both is yes.

The first is about liquidity: is the company able to pay its debts as they become due in the normal course of business? This is forward-looking and about timing. It does not ask whether the company is wealthy, it asks whether the money will be there when each obligation falls due.

The second is about the balance sheet: is the value of the company's assets greater than the value of its liabilities, including contingent liabilities? This is a point-in-time question about net worth, and the inclusion of contingent liabilities is written into the Act rather than being a matter of prudence.

They fail independently and for different reasons, which is why testing them separately matters.

Worked Example: Passing Both, Then Breaking One

Take the defaults, describing a reasonably ordinary New Zealand trading company.

Limb one. It holds $85,000.00 of cash and expects $1,240,000.00 of receipts over the next twelve months, against $1,180,000.00 of debts falling due in the same period. That leaves $145,000.00 of headroom, so the company can pay its debts as they fall due. Limb one passes.

Limb two. Assets at a defensible valuation are $1,450,000.00. Liabilities are $780,000.00 and contingent liabilities, being guarantees and lease commitments, add another $120,000.00, for $900,000.00 in total. That leaves $550,000.00 of headroom. Limb two passes comfortably.

The company therefore satisfies the solvency test as it stands. Now the shareholders want a $200,000.00 dividend.

After that distribution, limb two still passes with $350,000.00 of headroom, which looks reassuring. But limb one falls to -$55,000.00. The company would no longer be able to pay its debts as they became due, and because both limbs must be satisfied, the distribution cannot lawfully be made. The largest amount that keeps both limbs satisfied is $145,000.00, set by the liquidity limb.

This is the pattern that catches directors out. The balance sheet said there was $550,000 of room. The cash cycle said there was $145,000. The lower number governs.

Retained Earnings Are Not Distribution Capacity

A common and expensive misunderstanding is that a company can distribute whatever sits in retained earnings. Retained earnings are an accounting record of profits not yet distributed. They are not a pot of money and they say nothing about whether paying them out leaves the company solvent.

A company can have $600,000 of retained earnings entirely tied up in stock, plant and debtors, with $40,000 in the bank. The accounting entry permits a dividend. The solvency test does not.

The same applies in reverse: a company with modest retained earnings but strong cash generation may have more genuine capacity than its equity section suggests, though the Act also imposes separate requirements about the form of distributions that should be checked with your accountant.

Contingent Liabilities Are Where This Goes Wrong

The balance sheet limb explicitly requires contingent liabilities to be counted, and they are the items most often left out because they do not appear in the accounts as creditors.

The usual candidates are a guarantee the company has given for a related party's borrowing, the remaining commitment under a property or vehicle lease, a disputed invoice or a claim that has not yet been resolved, warranty or remediation obligations on completed work, and deferred or earn-out consideration on an acquisition.

Section 4(4) does allow directors to take account of the likelihood of the contingency occurring, and of any claim the company would be entitled to make against someone else. That is a genuine and useful allowance, but it is an exercise of judgement that should be written down at the time with the reasoning. It is not a basis for treating the exposure as nil because it probably will not happen.

Valuing The Assets Honestly

Section 4(2) requires directors to have regard to the most recent financial statements and to all other circumstances they know or ought to know affect the value of the company's assets and liabilities. Book value is the starting point, not the conclusion.

Practically, that means stock that will not sell at cost should be written down before the test rather than after it. A debtor in dispute or in liquidation is not worth its invoice value. Capitalised development costs or goodwill with no realisable value are worth nothing in a solvency assessment even if they sit on the balance sheet. Conversely, a property carried at historic cost may be worth considerably more, and directors are entitled to have regard to that provided they can support it.

Our current ratio and quick ratio calculators are useful supporting evidence for the liquidity limb, and the Altman Z-Score is a helpful early warning, though it has no legal standing here.

Why This Matters Personally To Directors

This is not a compliance formality. Under section 52 the board must be satisfied on reasonable grounds that the company will satisfy the solvency test immediately after the distribution, and the directors who vote in favour must sign a certificate to that effect.

If a distribution is made when the test was not in fact satisfied, it may be recoverable from the shareholders who received it, and a director who signed the certificate without reasonable grounds can be required to repay the company. Directors also carry separate duties under sections 135 and 136 concerning reckless trading and incurring obligations the company cannot reasonably be expected to perform.

The practical protection is contemporaneous documentation: the figures used, where they came from, the judgements made about contingent liabilities and asset values, and the reasoning. A test reconstructed after a liquidator asks the question is worth considerably less than one recorded on the day.

Related NZ Business Health Calculators

• Current Ratio Calculator: supporting evidence for the liquidity limb.
• Quick Ratio Calculator: a stricter liquidity test that excludes stock.
• Altman Z-Score Calculator: statistical distress prediction, useful as early warning but with no legal status.
• Dividend Imputation Gross-Up Calculator: the tax side of a distribution once solvency is established.
• Working Capital Calculator: the funding position underneath the liquidity limb.
• How Much Should I Pay Myself?: the background to this calculation.