insolvency

Insolvency is what happens when a firm or an individual cannot fulfil its financial obligations; e.g. it cannot pay its outgoings or debts in full or on time. A company is deemed insolvent when its debts are larger than its assets. There are several different types, including accounting insolvency, balance sheet insolvency (also known as technical insolvency), and cash flow insolvency. It is not the same as bankruptcy, which occurs when a court determines that insolvency should be resolved through legal orders. Some businesses operate in a permanent state of balance sheet insolvency while still being cash flow solvent, meaning that incoming revenue means that it can meet its debt obligations and avoid default, so, not all insolvency ends in bankruptcy. In this case, the business operates under technical insolvency rather than actual insolvency, which occurs when a firm is cash flow and balance sheet insolvent and therefore has no means to pay its debtors. To determine whether a business is cash flow insolvent, they should ask themselves whether they’re able to pay their bills in full and on time. If not, they are cash flow insolvent. To determine balance sheet insolvency, a business must look at all its assets (machinery, stock, property, ledger book) and weigh them against the company’s debts. Where debts are larger than the worth of the assets, the business is technically insolvent.

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