What Exactly Is Insolvency?


The dictionary definition of insolvency is less than illuminating, it is:

The state of being insolvent…

Listed synonyms provide more detail:

bankruptcy · liquidation · failure · collapse · ruin · financial ruin · ruination · pennilessness · penury · 

Digging Deep

what-exactly-is-insolvency

What these explanations do not provide is a definition of the state of insolvency. A simple definition could be the insolvency occurs when we are unable to meet our obligation to settle debts by the required due date.

In a business sense, a firm can be said to be insolvent if its assets are less than its liabilities, but even this definition does not quite hit the spot.

Visualising Insolvency

Imagine that you use all your available cash reserves to purchase stock. (To place this in a current context, you might consider this as a strategy to avoid supply line issues in the event of a no-deal Brexit.)

You have no issue with doing this as you’re owed a significant sum by your major customer. In theory, at the end of the month, your cash flow should restore before bills and salaries are due.

But what happens if your customer is suffering cash flow issues and is unable to pay?

what-exactly-is-insolvency

On paper, Your Business Will Be Solvent.

As long as your delayed payment from your customer does not become more serious, in time your cash flow will be restored, but how will you pay your bills at the end of the month?

Justifying Delays In Payments

Without private funds that you can introduce to see you through this impasse or the support of your bank, how will your staff and other creditors respond if you have to go cap in hand and explain there will be a delay in paying them?

Cash, liquidity, really is king, and lack of cash can actually place your business in the same position as an insolvent firm.

Ask Our Experts Advice

If you are concerned that you may be skating close to a cash flow crisis or deeper insolvency, please call so that we can help you figure out your available options.

For certain,  pretending that all will work out well, in the end, may not be the best strategy to apply.

 


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