Insolvency / Insolvent

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    When a company is unable to pay its debts, it has become insolvent.

    How is insolvency determined?

    There are two main ways in which a company can be deemed insolvent:

    1. Cash flow insolvency – this is when a company does not have enough cash flow (liquidity) to meet debt repayments as they become due.
    2. Balance sheet insolvency – this is when a company’s total liabilities exceed the value of its total assets.

    In some cases, it is illegal for a business to continue trading once it has been declared insolvent but in others, the company can continue under certain arrangements (see below).

    What are the consequences of insolvency?

    The consequences of insolvency can vary depending on the country, but the most common formal insolvency procedures include:

    • Company voluntary arrangement (CVA) – This is when the insolvent company and its creditors make an agreement to reduce or extend the repayment period for outstanding debts so that the company can continue to operate.
    • Administration – This involves an external company coming in to take over the insolvent company for an agreed period. The aim is for the external company to assess the insolvent company’s assets and work out if they equate to enough to pay off creditors.
    • Liquidation – If the insolvent company is not able to cover its debts through its assets, the company may be liquidated which effectively means the end of the business. The company’s remaining assets are sold and the cash is distributed between creditors.

    Prior to the above, there may be other, less formal attempts to help the company recover by either restructuring or reducing their debt.