How to distinguish between bankruptcy and insolvency
Anyone in business dreads hearing the words “bankruptcy” and “insolvency” because they are so disastrous for the financial health of the business. Private citizens often go through bankruptcy when their debts are insurmountable and they do not have the monies necessary to make the minimum payments. Although bankruptcy and insolvency are similar and often used interchangeably, they have different meanings.
A business goes into a state of insolvency when the value of the assets is less than the total of the liabilities. Bankruptcy is the next step when insolvency occurs unless the situation can be remedied in a drastic and rapid way. A company or individual is also said to be insolvent when there is no possible way to repay the debts when they come due. Bankruptcy is a legal procedure and people or businesses file for bankruptcy when they are unable to pay off their debts.
What is bankruptcy?
Bankruptcy is a legal process that people elect to go through when their finances are such that they are unable to meet their financial obligations. It has to be filed in court. In the United Kingdom and other countries of the world, bankruptcy is only applied to individuals who cannot pay their bills. Companies in the same situation are said to go into liquidation because they have to sell their assets to obtain cash and in this way they liquidate their assets.
Most people put off filing for bankruptcy until they start to receive notices and phone calls from their creditors. After the file has been made in the court, the court then makes the decision whether or not to sell the assets to repay some of the debts. It may also give the individual or company protection from legal action until a loan or some other form of financing can be put in place and the problem can be resolved to the satisfaction of all involved.
What is insolvency?
Insolvency refers to the same situation that a person finds himself in for bankruptcy. There is just not enough income to be able to pay the debts or make the minimum monthly payments. However, insolvency is not a legal term. It is just a description of the situation. It doesn’t mean that bankruptcy will naturally occur and there are ways of resolving the situation. In most cases, businesses can continue to operate because they do have sufficient cash flow from the business activities.
The difference between bankruptcy and insolvency
Bankruptcy occurs following insolvency and is the last resort. It happens when all possibilities have been exhausted and there is no other way to try to rectify the financial situation. Insolvency is only a term used to describe a situation where a person or business has more debt than income. It is not a legal term or procedure and does not mean that the next step is to file for bankruptcy. Bankruptcy, on the other hand, is a legal process and the court handles the decisions.
An insolvent business is not necessarily a bankrupt business. There are times when businesses become in solvent when they take on extra debt, but they are still able to continue because they have sufficient cash flow. As long as they are making their payments, the creditors are satisfied.
The reasons for filing bankruptcy are varied. It can be the result of poor business management, a natural disaster, such as a flood or earthquake, a recession throughout the country or lack of cash. Whatever the reason, it does mean that there is no possible way of being able to make the payments needed to control the debt or keep the creditors from demanding payment. A business can ask for help from the government to delay the bankruptcy proceedings so that it can come up with a solution to the insolvency problem.
Summary
- Insolvency is used to describe a situation where a person or business is unable to pay their debts by the appointed time.
- Bankruptcy occurs when a solution for insolvency cannot be found. It has to be filed with the court and involves a legal process.