Page 42 - Profmark_2024_Directors Guide

SOLVENCY AND LIQUIDITY TEST

Section 4: Directors have a duty to monitor the company’s financial position and ensure
that the company meets the solvency and liquidity test.
Solvency relates to the net worth or net asset value of the business, where assets are
valued on the basis of their market values and realisable values. The balance sheet
should reflect the solvency position of the business.
Liquidity is used to describe how easily the assets can be converted into cash, and to
describe the relationship between a company’s liquid assets and short-term financial
obligations, when and as they become due.
The solvency and liquidity test is an accounting exercise. The Act states how the various
values are to be calculated and what assets and liabilities are to be taken into account.
Some of the transactions that will require that the solvency and liquidity test be satisfied
include:
■ The provision of financial assistance to third parties for the acquisition of the
company’s own shares – for example, where the company lends money to a person
to enable the latter to acquire the company’s shares (Section 44)
■ Loans or other financial assistance to related parties, including subsidiary
companies, holding companies and directors (Section 45).
■ Dividends or other “distributions” (as defined in Sections 1 and 46)
■ The issuing of capitalisation shares on terms whereby the recipient can choose
whether to take the shares or to take cash (Section 47)
■ Share buy-backs – in other words, where the company buys back its own shares
(Section 48). No special resolution has to be adopted when the company is
implementing a pro-rata share buy-back where the shareholders affected are also
the directors of the company (this is per the amended clause 48 of the Amendment
Act)
■ An amalgamation or merger with another company (Section 113).
In order to remain compliant with the Act, directors must constantly monitor whether
a transaction that the company proposes to enter into will require that the statutory
liquidity and solvency test be satisfied as well as the additional provisions of each
particular section of the Act.
Directors must then take account of the necessary information to enable them to make
the requisite determination of the company’s solvency and liquidity.
In terms of the Act, a director will be personally liable for any loss, damage or costs
sustained by the company if the director acquiesced in the conduct of the business of

40