During difficult financial times, a business can end up in a situation where it’s considered insolvent. In many situations, this can lead to bankruptcy for the business. However, these are two very different states of business.
Many companies will consider insolvency a guaranteed path to bankruptcy, even when this isn’t necessarily the case. Getting to know the inner workings of insolvency and the bankruptcy process is crucial for businesses that are going through difficult times. Before you decide to take drastic measures, you should become well-acquainted with them.
What is insolvency?
When a company’s liabilities pile up, this presents an issue for its outstanding debts. Normally, the assets of a business or individual are weighed and compared to its liabilities in order to determine whether or not they can pay their debts in theory. If the liabilities are greater than the sum of its assets, the legal entity is insolvent.
Many business owners in Australia dread the idea of insolvency, but it’s not something that’s set in stone. You can think of it as a state of being rather than a label that leads to anything concrete. There are many ways for a business to change its current state and avoid issues with outstanding debts.
What is bankruptcy?
Bankruptcy is quite a bit different from insolvency. This is a specific legal process that defines the business as unable to pay off its debt. If the individual or business has an outstanding debt over a certain amount and no assets to back it up, this can lead to bankruptcy.
In some situations, a court decides that the business is bankrupt, while in others, the individual themselves will petition for bankruptcy. Once the process of bankruptcy starts, a civil servant will begin overseeing it. Bankruptcy is a last resort solution, which is why Australian businesses will generally want to avoid it.
The different types of insolvency
There are different kinds of insolvency that imply different states of the business. Knowing your business is insolvent is one thing, but you need to know exactly what type of insolvency it is in order to start resolving the issue.
If your business can’t pay off its debts because there is no cash to finance these payments, then it’s a cash flow insolvency. This situation usually occurs because the business has already exhausted other solutions for resolving debt.
Once the money dries up, there are no funds to pay off debt. Running out of liquid assets is a real threat to businesses with high liabilities, which is why creating liquidity is so important.
Some businesses use a balance sheet insolvency test to determine whether or not they can stay afloat with high liabilities. This is a condition known as having negative net assets.
Finding solutions for insolvency
Depending on the type of insolvency, you can do a number of different things to improve your current situation.
Financial advisors will recommend that businesses with balance sheet insolvency review their business operations first and foremost. If the current debt can be eliminated or mitigated, this would be the first step to take. The company should make moves to convince the creditor that future cash-flows will increase in the current business model.
Many Australian businesses that are in a state of insolvency don’t realize that there are countless options for resolving debt and negotiation with creditors. Finding immediate insolvency solutions in Sydney is a lot easier today than it was before, as creditors are more lenient with businesses that show potential for future cash flow. It’s in their best interest that the business continues operating, as this might lead to the debts getting paid eventually.
Insolvency vs bankruptcy
It’s hard to say when a business should decide to remain insolvent and try to find solutions for the financial issues that plague them, and when they should file for bankruptcy. It really depends on the mindset of the business owner or owners and how viable they believe their business to be.
While insolvency is merely a state of the business that doesn’t necessarily warrant drastic actions, it’s still a stressful situation that doesn’t bode well for the future of the business.
If the situation doesn’t improve with the help of insolvency solutions, bankruptcy is always an option.
It’s clear that insolvency and bankruptcy are two very different situations that warrant different behaviour by the business. In the case of insolvency, there are many steps that a business can take before deciding to file for bankruptcy.
Cash flow and efficiency can be improved in a number of different ways, and there are many solutions that can be applied for large amounts of debt. Consider them and consult your financial advisor before deciding to take action.