What is Insolvency and How Do Businesses Deal with It?

Fri, Oct 26, 2012

Financial Advice

Insolvency is a very serious situation for any business to be in. It means that it no longer has the ability to pay debts. In many places, continuing to run an insolvent business is against the law, as it can further increase financial difficulties. Having said that, if there is any reasonable way that the business can be kept going, this is the preferred choice for everyone involved. The business owner can carry on with their work, and creditors are more likely to recover more of their money.

There are in fact several types of insolvency. Cash flow insolvency means that a company does not have the liquidity which would allow it to pay its debts on time, as they are due. If a business is regarded as balance-sheet insolvent, it means that it has negative assets; i.e. the value of its liabilities is greater than that of its assets. While both issues are not a good situation to be in, serious difficulties arise when a company is both cash-flow and balance-sheet insolvent. Illiquid assets for instance, can make a company cash-flow insolvent, but still perfectly balance–sheet solvent. It is important to notice that bankruptcy is a legally-determined state, where insolvency is not, and in the UK, bankruptcy is a term used only for individuals.

In the US and UK, and many countries around the world, restructuring or administration is the favoured choice when businesses become insolvent. It is a process whereby a business gets protection from creditors so that it may reorganise itself in such a way that means that it can continue running, or results in a more favourable outcome than liquidation for the creditors. In the US, the company directors may enact these changes, but in the UK, a licenced insolvency practitioner must be appointed. The reason for this is that the law believes a neutral party must be involved in order to protect the creditors, and ensure that the eventual outcome is balanced. In both cases, if restructuring does not eventually solve the problem, or simply gets creditors a better deal, the company is liquidated and its assets sold off.

Both the US and the UK have laws which mean that creditors are entitled to be heard in court, and if the situation is serious enough, the court has the power to force the company into liquidation so that remaining funds can be distributed among creditors. This is to ensure that a company in an extremely serious situation cannot run up extra debt and cause more problems while attempting to resolve the insolvency.

Businesses who believe they are being faced with any form of insolvency should always seek proper financial advice in order to resolve the problem before it is too late. Thousands can be saved if professional help is found in the right timeframe. Gibson Hewitt – Licensed Insolvency Practitioners are an established firm that provide problem solving services for both businesses and individuals in financial difficulties.

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