Bankruptcy vs insolvency: What's the difference?

Insolvency and bankruptcy are two scary words for any person or company. This is often confusing to the average Australian, as they cannot distinguish these two things. Insolvency is a state of an organization when it does not have the financial ability to pay off its payment obligations. The definition most specifically describes the concept itself and allows you to cover all the main types of this phenomenon. It should not be confused with bankruptcy. The bankruptcy of a legal entity means the insolvency of this person recognized by the judicial authority, which has a stable character. As a result, the court makes a decision on the termination of further entrepreneurial activities of the insolvent business entity with a compulsory collection of debts. Let’s take a closer look at the differences between these terms.

Reasons for insolvency

The size of the undertaken obligations determines the solvency of the organization. This is considered to be a company that owns all assets and has no liabilities. Also, a solvent is called a company that does not have its own capital but pays off all obligations on time at the expense of the proceeds.

Signs of insolvency

Signs of impending insolvency are determined by the obligations formed on the basis of the terms of contracts and relations in the form of an oral agreement.

To do this, you can take into account the elements of obligations:

-the amount of work performed and unpaid for the shipment of goods or the provision of services;
-overestimated the cost of work, which is considered as unjust enrichment;
-unpaid wages and social benefits;
-the number of outstanding loans or credits, full or partial, including interest;
-debts to founders and other participants;
-property damage to the creditor.

Insolvency levels

The main criterion by which the degree of insolvency is assessed is the time during which it is possible to eliminate the problem. The time indicator gives an idea of its depth. This is the main criterion for insolvency. Based on this, its five levels are distinguished. The time intervals, in this case, are established in accordance with the law "On bankruptcy" and determine its degree. Let's consider them in detail:

1. Incipient level. The company stopped fulfilling its obligations more than three months ago. Such a delay is the reason for initiating a case on the fact of the bankruptcy of the company.
2. Progressive level. Since the initiation of the bankruptcy case and for seven months, the company has been monitored.
3. Steady level. This is a period of stabilization. It lasts two years since the end of the observation and is intended to rehabilitate the enterprise.
4. Chronic level. In this case, there are no strict deadlines. The duration of this period is determined by the duration of the settlement agreement, which can be concluded up to 25 years.
5. Absolute level. The company does not have any opportunity to restore its solvency, or the potential rehabilitation period is so long that it is longer than the maximum allowable period of the settlement agreement.

Factors provoking bankruptcy

Economists have a concept for a clear definition of the economic essence of bankruptcy - the net negative value, which is calculated by deducting the existing capital of a legal entity from the mass of its monetary obligations.
Non-payments must be chronic in nature - the period of delay is at least 3 months.

The legislation stipulates that the prerogative of declaring both an individual and a legal entity bankrupt is fully assigned to the court. Moreover, an insolvency case can be conducted exclusively by the judicial authority at the place of the official registration of the debtor.

Both the debtor himself and on behalf of the person who has material claims against him have the right to appeal to the judicial authority. Also, authorized bodies representing the state can act as an applicant.

The essence and causes of bankruptcy in each specific case may be different, but the general harbingers of the ruin of enterprises can be seen quite clearly. The reasons for bankruptcy can be either independent of the management of the enterprise, or become a direct consequence of its management:

-ineffective economic policy;
-use of outdated equipment and technologies;
-irrational use of working resources and capacities of the company and, as a result, high production costs;
-delays or lack of payments from partner enterprises (in some industries, dependent organizations go bankrupt along the chain);
-low level of marketing, insufficient to study existing sales markets and promote your product;
-using loans on unfavorable terms;
-overly active rates of expansion of production and, as a result, sharply growing accounts receivable (sales rates are lower than the rate of production).
-the crisis of the country's internal economy;
-high inflation rate;
-political instability, due to which foreign sales markets are being lost;
-increasing competition in the international market.

Bankruptcy and Insolvency: Similarities and Differences

The similarity of these two phenomena is that they both arise from non-payment of debt obligations, their relationship is that the current liabilities significantly exceed the assets.
Another similarity is that if you find yourself in either of the situations, the best solution would be to seek professional help. A proven tax accountant from Sydney can help you.

Although both terms have almost complete similarities in their essence, in reality, their ratio is different. The main differences include:

The bankruptcy procedure itself is a process regulated by the state and decided in court, and insolvency is more the financial condition of a company or an individual.
Insolvency may not lead to bankruptcy, while all companies that have gone through such a procedure are insolvent.
Going to court with a statement is an extreme and voluntary measure. At the same time, insolvency may arise suddenly and be temporary.
The main difference is in the credit rating - in one situation it falls sharply, and in another, it practically does not change.
Under a legal procedure, all assets are liquidated, and monetary obligations are paid to creditors.

Conclusion

Often, the words "insolvency" and "bankruptcy" are perceived as synonyms, which is fundamentally wrong. This creates certain difficulties in identifying these concepts. In the economic literature, you can find such a term as "hidden bankruptcy". It means that the value of the company has fallen, but does not indicate insolvency, and even more so the bankruptcy of the company in the conventional sense.