Many businesses go through a period of insolvency at some point. It can lead to bankruptcy, but it doesn’t have to. Business owners who recognize the issue early and take steps to do something about their insolvency may be able to turn things around. However, that’s difficult if there are outside forces beyond their control, like larger economic conditions or a changing market.
It’s important to understand just what insolvency is and what types there are. Insolvency is defined in U.S. bankruptcy law as a “financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at fair valuation.” There are two primary types of business insolvency.
Accounting insolvency
Accounting insolvency (also known as business sheet insolvency) occurs when a business’s debts are greater than its assets. This can be difficult to recover from without an influx of money because if the business sells off some of its assets to pay its debts, it’s just going to end up with even fewer assets – some of which may be necessary to operate the business.
Sometimes if a business owner can convince their creditors to have faith in them to recover from their insolvency, they can persuade them to accept payments in installments or even to agree to accept a percentage of what they’re owed. Some creditors might see that as better than getting nothing. However, they might not want to continue to provide goods or services to the insolvent business.
Equitable insolvency
With equitable (also referred to as cash flow) insolvency, a business’s total assets (both fixed and liquid) exceed its debts. However, the business doesn’t have enough liquid assets to pay their debts. That means the business would probably have to sell some of its fixed assets (like buildings and equipment) to keep up with its debts. That can seriously affect it. A business might need to downsize and possibly change its product line or move to an online company.
Financial issues that lead to insolvency and potentially bankruptcy rarely, if ever, solve themselves, and they typically don’t improve over time without a clear strategy. Getting experienced legal guidance as early as possible can make all the difference.