The balance sheet test assesses if the total liabilities of the company exceed its total assets, in which case it is deemed to be balance sheet insolvent. In other words, it tests whether the company's assets could cover all liabilities if they were due immediately. As opposed to the cashflow test, the balance sheet test points to a potential insolvency, but not necessarily in the short term. The implications of failing the balance sheet test depend on the jurisdiction, the individual court's interpretation, and the intentions of the party requesting the test. The mildest consequence is that the company is not able to pay dividends. If a company fails the balance sheet test, it means the company must have negative equity book value, which in turn precludes the payment of dividends. In a more severe scenario, a creditor can use a failed balance sheet test as evidence of the company's inability to pay its debts and force it into insolvency proceedings, which is a formal measure taken to deal with companies unable to meet their financial obligations. At the end of the day, the balance sheet test is a bit subjective as although some companies may technically fail the test based on what's shown at a point in time in their statutory balance sheet, i e, they have total liabilities exceeding total assets. They may be perfectly able to continue operating as a going concern for several reasons. The courts may simply not rely on the values shown by the auditors on a company's balance sheet and may request the reassessment of certain assets and liabilities in light of the available evidence and circumstances of the particular case. Ultimately, the courts will use their discretion to assess whether a company has sufficient assets so that it can reasonably be expected to meet all of its liabilities.

A case study illustrating this point is Eurosail. Eurosail was a special purpose vehicle used for the securitization of a portfolio of mortgage loans. It was partly financed by certain loan notes provided by creditors.

Eurosail's latest audited balance sheet showed that its liabilities exceeded its assets by over 74 million pounds. Despite that Eurosail continued to pay interest and principal under the loan notes when due, a group of its loan note holders went to court arguing that Eurosail was insolvent under the balance sheet insolvency test, the courts decided that the company was not balance sheet insolvent under the balance sheet test. Holding that the fact that a company's latest audited balance sheet showed a net deficit did not necessarily mean that the company was balance sheet insolvent and mentioned the need to consider the specific circumstances of each case before deeming a company insolvent under this test.