Insolvency

There are two main tests of insolvency. Cash-flow insolvency means being unable to pay debts when they are due, even if the business owns valuable assets. Balance-sheet insolvency means total liabilities are greater than total assets.

For example, a company might own buildings worth millions but be unable to pay suppliers and employees because it has run out of cash. It is cash-flow insolvent, even though it may be solvent on its balance sheet.

Insolvency is a financial condition, while bankruptcy is a legal process. In many countries, including the United Kingdom, bankruptcy applies to individuals, while insolvent companies go through processes such as administration, liquidation or company voluntary arrangements. In the United States, bankruptcy applies to both individuals and companies.

Directors of companies approaching insolvency often have legal duties to consider the interests of creditors, and may face personal liability if they continue trading when there is no reasonable prospect of avoiding insolvency. Insolvency does not always mean the end of a business. Some companies are rescued through restructuring or sale, while others are wound up and their assets sold to repay creditors.