Insolvency vs Bankruptcy: Everything you need to know

The term ‘bankrupt’ carries with it hundreds of negative connotations, whereas insolvency is perhaps viewed with less malice. They are two terms that both indicate financial trouble for a company but there are important differences between them. In order to understand those differences we have to unpick exactly what each term means, which might apply to you and how you can be insolvent and bankrupt but not necessarily bankrupt and insolvent.

Our specialist restructuring and Irwin Insolvency team provide expert advice on a wide range of matters arising from the financial distress of a business.

What is insolvency?

Essentially, when you’re insolvent it means you can no longer pay your debts. So, when filing for bankruptcy you are most likely going to be insolvent. Generally, however, it’s a term used to refer to businesses, either in terms of cash flow insolvency, which is when you don’t have enough liquid assets to pay your debts but you still own some tangible assets, or balance sheets insolvency, which means you have neither.

An example of insolvency – Insolvency is generally utilised as a term when a business can no longer continue trading and this can be due to a number of reasons. There could be a cash flow problem, you might have lost customers or contracts or your business might simply owe too much.

What is bankruptcy?

Bankruptcy is the legal process that an individual goes through when they can’t afford their debts and must file with the courts to seek relief from your debts. Once declared bankrupt, creditors can no longer demand payment from an individual and assets will generally be used to pay off your debt in a controlled manner until the end of the agreed-upon bankruptcy period.

An example of bankruptcy – If an individual decides to buy something on credit and then finds themselves in a situation where they can’t pay that credit because they don’t have enough money or assets, they could apply for bankruptcy if that bill is over £5,000. Note that their bankruptcy will be on record for six years and might mean they struggle to claim credit in that time.

How to avoid insolvency and bankruptcy

Bankruptcy is really just one type of insolvency and it’s by no means the only way out of it. Indeed, restructuring and insolvency often go hand in hand. Either way, however, it’s always better to avoid, if possible. 

The best way you can avoid insolvency and eventual bankruptcy is to hire an accountant to keep track of your funds. Handing your accounts over to an experienced third-party takes a lot of the pressure off you too and allows you to focus on the more important aspects of your company. 

If bringing on a third-party seems like something you’d rather avoid, meanwhile, you could hire your own accounting department or invest in some bookkeeping software to keep track of everything. Accountability is honestly half the battle here.