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The terms bankruptcy and insolvency are often confused because they are closely related. The word “bankruptcy” comes from the Italian word “bancoo rotta“, which means “broken bench”. Hence the word bankruptcy. These two terms have little in common: they both appear when liabilities exceed assets, and when companies/individuals cannot repay their debts.
What is Insolvency?
Failure to repay debts. There are many ways to deal with bad debts, such as, change the debt structure or change the flow of repayment.
Asset cash flow insolvency occurs when the debtor is unable to return the funds. When debtors are unable to repay their debts, insolvency becomes a major obstacle.
For example, if you own a house but do not pay the premium in advance, your house will be foreclosed and you will be in default. If someone does not meet the minimum monthly requirements, so does the credit card, which may prove insolvency.
There are two types of Insolvency:
1# Insolvency of cash flow
2# Balance sheet insolvency
Insolvency is a wake-up call for the financial system. For a long time, the lack of alternative financing options, bad relationships with banks, and outstanding creditors who exceeded the terms of the negotiations could not be resolved and led to insolvency. In order to determine whether the balance sheet is insolvent, the company needs to perform an assessment.
What is Bankruptcy?
This is the final condition for the failure of other debt repayment attempts. In the case of bankruptcy, the company itself was declared bankrupt in court.
There are two forms of bankruptcy:
1# Reorganization
2# Bankruptcy liquidation
Bankruptcy reorganization refers to the liquidation of the debts of individuals or companies. Bankruptcy Liquidation means that a person/company sells its assets to pay off debts.
There are two ways to file for bankruptcy: A person filed for bankruptcy by himself, which is called a “debtor application.” When the court issues an order and declares a company or individual bankrupt, it is called a Sequestration order.
Insolvency vs Bankruptcy
| Differences | Insolvency | Bankruptcy |
| Meaning | This is a situation where a company cannot pay its financial and operating debts. | This is the final state in which the organization filed for bankruptcy because it was unable to pay its financial and operational debts. |
| Relevance | This is related to the structure of financial debt. | This is related to the concept of law. |
| Credit Rating | Not affected by Insolvency. | Affected by Bankruptcy. |
| Behaviour | Temporary | Permanent |
| Process | Involuntary | Voluntary or Involuntary |
- As you can see, bankruptcy and insolvency refer to two different annual accounts. Although the term “bankruptcy” is often used to describe a situation where a person or company is clearly bankrupt and unable to repay debts, it is still a misnomer. The word they are looking for is insolvency. Just because a person or company goes broke does not mean they are bankrupt.
- To go bankrupt, a natural or legal person must first apply to the court for bankruptcy. As mentioned earlier, this is the actual legal procedure for liquidating assets and re-adjusting assets. Bankruptcy is just a financial report that someone can sue. It is discovered when your debt exceeds your assets. Therefore, if bankruptcy is actually insolvency, then the insolvent is not necessarily insolvent.
In addition, insolvency can be resolved without a court, but bankruptcy cannot.
- Insolvency occurs when the debt on the balance sheet increases, but it also occurs when the outflow of funds exceeds the inflow of funds, because this may be related to the balance sheet and cash flow. We only talk about bankruptcy when we declare bankruptcy in accordance with the law.
- The credit rating will only change when there are major changes. Since insolvency is dissolvable and has a time limit, this has no effect or changes in creditworthiness. Bankruptcy does not require billing, so it has a major impact on your reputation.
- Insolvency can be resolved by improving the debt structure and increasing cash flow. The insolvency lasts for a limited period of time until you exceed your assets and then your debts. Therefore, bankruptcy is not permanent solution. For example, if a company does not have enough sales and cash flow to conduct business, the company may not be able to pay for daily expenses, but it can still be resolved.
- To declare a company bankrupt, an individual must file a lawsuit and go to court, so this is voluntary. It may also happen that the court declares an individual or company bankrupt, so it can also be voluntary. On the other hand, insolvency is involuntary.
- There are several indicators that can be used to predict insolvency. The increase in debt on the balance sheet and the loss of cash flow led to insolvency, but if the insolvency lasts for a long time and is not resolved, it may lead to bankruptcy. If the company goes insolvent and files for bankruptcy, it is time for liquidation. If the company’s board of directors believes that the company should be liquidated, it should be further liquidated.
Preventive Measures to Avoid Insolvency & Bankruptcy
It is important to understand what can lead to bankruptcy and insolvency, so that you can recognize warning signs and act in a timely manner before debts appear. Protect yourself from accidental litigation or loss of income. Remember that even healthy companies can default if financial management is not done well. This means that debts cannot be repaid in time. For example, you may find that the only way to repay your debts is to sell important assets of your business, which is obviously inconvenient if you want to continue working.
If you are a small business owner, you should have an accountant by your side who will manage your finances and keep track of your balance sheet. To start a business, you need to focus on many areas and errors. This can happen when you are trying to complete work on a tight schedule. Transferring your account to a professional will reduce your risk of bankruptcy and insolvency.
The Bottom Line
These two terms are closely related to each other. When one ends, the other begins. When insolvency is over, bankruptcy begins. Not every insolvent person/company must go bankrupt, but every bankruptcy must be insolvent.
