The terms “insolvency” and “bankruptcy” are often used interchangeably, when in fact, they have different meanings. While the two financial concepts are similar in the sense that they both deal with large amounts of debt, each one comes with different financial hardships.
So how is insolvency different from bankruptcy? Read on to find out.
What Is Insolvency?
Insolvency is a financial state that an individual or business reaches when they’re unable to pay their debts in due time. Failing to pay debts on time usually leads the creditors to take action against you, such as filing a notice of foreclosure or asking the court to declare you bankrupt. Individuals and businesses can become insolvent for several reasons, the most common being job loss, salary reduction, medical bills, divorce, reckless spending, and financial mismanagement. There are two types of insolvency: cash-flow insolvency and balance-sheet insolvency.
An individual or entity becomes cash-flow insolvent when they don’t have enough liquid capital to pay their urgent debt despite having more assets than liabilities. In other words, the property they own is worth more than their debt, but they don’t have cash available at hand to service that debt. It usually occurs when one has run out of assets to sell and options to borrow money. Balance-sheet insolvency, on the other hand, is when the outstanding debts are greater than the total value of the assets you own. It means that you might be able to meet your payments with the cash you have on hand, but it will be at the expense of your financial stability.
What If You’re Insolvent?
Fortunately, there are ways to resolve insolvency and pay your debt, which include liquidating assets, cutting costs, borrowing money, applying for a loan, or getting a second job to increase your income. You can also negotiate a debt payment or settlement plan with your creditors, either personally or through a debt management company. Alternatively, if you are likely to return to profitability in the near future and can pay off your debt over an extended period of time, then the folks over at Bournemouth Insolvency Practitioners | Antony Batty & Company suggest applying for an Individual voluntary arrangement (IVA) or a company voluntary arrangement (CVA). In this case, you’ll need to engage the services of an insolvency practitioner who can work out with your creditors how much you can afford to pay, and how long the IVA or CVA will last.
While it may provide temporary relief and help you get back on your feet, if you enter an insolvency agreement, your details will be registered on the National Personal Insolvency Index (NPII) forever. Plus, the agreement will be listed on your credit file for 5 years, which can seriously impact your chances of borrowing money in the future.
What Is Bankruptcy?
People often turn to bankruptcy as a last resort to stop financial hemorrhaging, solve insolvency, and gain legal protection from their creditors for said period to allow them to pay off their debts easily. The two common types of bankruptcy are chapter 7 and chapter 13 bankruptcy. Chapter 7 is concerned with erasing unsecured debts such as credit card bills, whereas chapter 13, on the other hand, focuses on reorganizing secure debts, such as mortgages in a reasonable way that allows an individual or organization to continue making payments.
What If You’re Bankrupt?
Filing for bankruptcy is a lengthy legal procedure that involves many steps. First of all, you need to prove insolvency before you can be eligible to file for bankruptcy. Then you will have to meet with a licensed insolvency trustee to file the paperwork, contact your creditors, and see which assets can be sold. You will also have to comply with bankruptcy duties that include attending credit counseling sessions. This process typically takes between 9 and 21 months. After successfully completing all the necessary tasks, your outstanding debts will be cleared and you will become solvent again.
Although it gives you the ability to start anew, bankruptcy can severely damage your rating and affect your ability to borrow money for years. It will also impair your ability to travel overseas and apply for some types of jobs. Plus, bankruptcy, too, will appear on your credit file for 5 years, and it will be listed on the NPII forever.
To sum up, insolvency is a financial state where a business or person is unable to meet their debt payments on time, while bankruptcy, on the other hand, is a legal process that happens when an entity or individual declares that they can no longer pay back their debt. You can be insolvent without declaring bankruptcy, but you can’t be bankrupt without filing for insolvency. As with everything in life, both financial situations come with their own unique challenges and solutions. At the end of the right approach will depend solely on your particular case, so before you move forward with any decision, be sure to consult with an expert financial advisor.
Published by Matthew Piggot