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Insolvency

What is insolvency and what does it mean in business?

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Insolvency is a situation that occurs when a company or individual can’t pay their debts or creditors in full when they are due. A company can be classed as insolvent when its debts outweigh its assets, though this doesn’t necessarily mean the business cannot recover. Insolvency is also different to bankruptcy.

Before the state of insolvency is made formal, there is often a period of informal arrangements with creditors to try and find a way for the debts to paid without the business folding.

The risk of insolvency can arise for many different reasons, including a loss of cashflow from poor sales or other factors, an increase in costs from production or materials, or poor financial management.

Key points about insolvency
    • Insolvency occurs when a company or person is unable to pay off debts that are due.
    • It’s a state of financial distress that can be resolved by making arrangements with creditors to pay off debts and doesn’t always lead to bankruptcy.
    • Insolvency can happen due to many reasons, such as external factors that reduce cashflow, or poor financial management.

Understanding insolvency

Entering a state of insolvency is about being unable to pay off debts that are due, whether that’s as a business or an individual. This can progress to insolvency proceedings, which is a legal process taken against the insolvent person or company wherein assets such as property or stock may be liquidated in order to pay off the debts.

This is usually a last resort however, as creditors will try to come to an arrangement to restructure debts to make them manageable for the insolvent company or person. Naturally their priority is to recover their money, and usually this is more likely if the business can keep operating rather than collapsing.

The company can come up with a plan to restructure the debt and repay it over a longer period in smaller instalments, while making internal changes to reduce costs or boost sales to continue profitable operations.

Insolvency vs bankruptcy

At first glance, insolvency may sound the same as bankruptcy, but they are different states of financial distress with different implications.

Insolvency occurs when a business’s liabilities outweigh its assets, but it’s a temporary state that can be escaped through careful management and arrangements with creditors. Bankruptcy is a more advanced stage of insolvency when a court order is issued and a plan put in place to pay the debts.

The causes of insolvency  

There are many reasons why a business or a person could fall into insolvency, both from external factors and internal management practices. The rising cost of suppliers or raw materials can contribute to a business’s insolvency, as well as a loss of customers due to increased prices or stronger competition.

A business could also be the target of a lawsuit from a customer or supplier, which could result in large legal bills and damages, or even a ceasing of operations.

Internal factors could include poor financial management such as incorrect budget reporting that leads to an overspend, or a lack of control on company expenses.

 


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Insolvency FAQs

What happens when you go into insolvency?

Insolvency is a state of financial distress where a business or person cannot afford to pay their debts that are owed. While it can lead to bankruptcy, insolvency itself may only be a temporary state from which its possible to escape by restructuring repayments and making agreements with creditors to clear the debts.

What is personal insolvency?

In the UK, personal insolvency is when an individual is unable to pay their debts when they come due. Bankruptcy is a type of insolvency that involves a court ordered plan to repay the debts, but a person can be insolvent without being declared bankrupt, and can make agreements with creditors to restructure the debts so they can be repaid.


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Why choose Hitachi Capital Invoice Finance as a way to improve your working capital

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Smarter, Faster and Simpler Cashflow Finance with Hitachi Capital

Smarter, Faster and Simpler Cashflow Finance with Hitachi Capital

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