Difference Between Insolvency and Liquidation

Any company starts with the objective of becoming a leader in the market. Unfortunately, not always things happen the way we intend them to happen. Business for many beginners is one of the biggest risks they may take. It might result in either success or failure. Nothing is predictable in case of a business. It is not always the law that a business must flourish with funds. The other side can also happen. Insolvency is a situation which denotes a company’s inability to pay back its debts.

Insolvencies are of two types. They are cash insolvency and balance sheet insolvency. Cash insolvency is the case when a company is unable to repay its debts. Balance sheet insolvency is the case when the company has liabilities greater than that of its assets. Cash insolvency can happen when a company has fixed assets that cannot be liquidated. For example, a company has a cash debt of $50, 000, and fixed asset worth of $1, 00,000, then the company is said to suffer from cash insolvency. However, its balance sheet is solvent since the values of its assets are greater than that of its debt. Cash insolvency would be easily managed and would be easily handled if the balance sheets were solvent. However, the reverse does not hold true.

A company must always ensure that its assets are always greater than that of its liabilities, at the end of every financial year. This prevents the company from falling into insolvent state. There are different laws in different countries to handle problems related to insolvency. It is the responsibility of a company to follow the appropriate laws.

Insolvency at a smaller level could be resolved by incorporating cash adjustments here and there. However, if it occurs on a large scale, then the company is left out with no other option but to go into liquidation. Yes, liquidation literally denotes the termination of a unit or operation of a company. Sometimes, the entire company will have to be liquidated. It is known as “wipe-out”, in a lay man’s language. A company decides to liquidate its operations only under extreme conditions. No proprietor or shareholder would want a company to liquidate.

Liquidation is of two types. One is compulsory liquidation, and the other one is voluntary liquidation. Compulsory liquidation is the case in which the company owing to exceeding debts is compelled to liquidate. In the former, the shareholders or the government make the company liquidated. Voluntary liquidation, as the name suggests, is the case when the company willingly winds-up its operations and divides its assets to the shareholders. There are different procedures in different countries for carrying out this liquidation. The company must follow the appropriate procedure.

Source by Freeman Scott

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