What Is Insolvency?

What Is Insolvency?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

Insolvency is a term used in finance to describe a situation when an individual or business can’t pay the money owed, on time, to creditors. It may also refer to a circumstance where the value of assets held by an individual or business is less than its liabilities. This financial state can lead to insolvency proceedings, where legal action might be taken by creditors to recover money owed to them.

Related Questions

1. What is the difference between bankruptcy and insolvency?

While both terms relate to a state of financial distress, bankruptcy is actually a legal process that follows insolvency. Insolvency is the financial state where you are unable to meet your debts when they are due, or you possess more liabilities than assets. Bankruptcy, on the other hand, is the process a person undergoes when they are declared insolvent by a court. It includes legal measures to resolve their financial difficulties, often by selling assets to pay off the debts.

2. What causes insolvency?

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Several factors can lead to insolvency, including poor cash management, reduction in cash flow, poor financial forecasting, lack of financial control, loss of market, and even external circumstances such as recessions or global economic downturns. Sometimes it can be due to mismanagement not only of business resources but also personal ones in the case of individual insolvency.

3. What are the signs of insolvency?

Common signs of insolvency include persistent cash flow problems, constant late payments to creditors, inability to meet regular financial obligations like payroll or utility bills, and legal actions such as receiving County Court Judgments. A simple test could be if you can’t pay bills when they become due or if your assets are less than your liabilities.

4. Is insolvency the same as liquidation?

No, insolvency and liquidation are not the same. Insolvency refers to the financial state of not being able to pay back debts. Liquidation is a process that often happens as a result of insolvency. It involves turning a company’s assets into cash to pay off debts and then closing the business.

5. What are potential insolvency solutions?

Various solutions are available for insolvency depending on the situation. For individuals, these might be an Informal Arrangement, Individual Voluntary Arrangement, Bankruptcy or even Debt Relief Orders. For companies, options can include Administration, Company Voluntary Agreement, or Liquidation. The right solution depends on many factors such as the level of debt, assets, income capability, to name a few.