What is Insolvency?
Often due to raised expenditures, low cash inflow, or inadequate cash-flow management, an individual or an entity becomes incapable of compensating for the due debts. This financial stress position of the company leads to its Insolvency.
The next step in insolvency proceedings is liquidation, in which the assets and resources get divided among the creditors. And the business gets shut down.
Alternatively, an insolvent entity can make contracts or informal meetings with beneficiaries to reorganise debts and clear them off.
Types of Insolvency
Insolvency is of mainly two types:
- Commercial Insolvency: When insolvents become incapable of resolving financial issues even though assets are more than liabilities, the state of commercial Insolvency gets formed.
- Factual Insolvency: It happens when the defaulter’s liabilities are higher than the assets, which results in the incapability to clear due debts.
This difference helps find whether an insolvent individual or company can get rescued.
What is Bankruptcy?
Halting the legal proceedings by creditors against the insolvents, debtors and companies who fail to pay their exhausting debt burdens is bankruptcy. It aims to provide financial remedies to the debtors.
Derived from the Italian Banca rotta, the word Bankruptcy in the literal sense means “broken bank”. This procedure of staying in legal action prevents creditors from getting wrongful gains over another.
One can file for bankruptcy to overcome the hardships in clearing the debts. The process includes the following steps:
- Prepare your Balance sheet, and make a financial record.
- Consult a lawyer. He will help you throughout the bankruptcy proceedings.
- Ask your lawyer to file a petition under the Provincial Insolvency Act. The lawsuit will ask the court to declare that you are bankrupt with your financial record, and it will further prevent you from getting detention for unpaid debts.
- The court will decide whether you are bankrupt. Get an interim order to halt any legal action by creditors.
What is the Difference between Insolvency and Bankruptcy?
Here are some key difference between Insolvency and bankruptcy:
- Being bankrupt denotes that you can pay off your debts by reconstructing the financial contracts or selling your assets. While Insolvency is a state in; which you cannot clear your due debts.
- Insolvency is a situation in an individual or a company wherein it cannot clear the debts. Bankruptcy is a method of legal proceedings.
- Insolvency is the ‘way of being’ while bankruptcy is the result.
- Insolvents may get declared bankrupt if not treated, but not the opposite. Bankruptcy is a final declaration by the court.
What is Insolvency under the Insolvency and Bankruptcy Code, 2016?
To regulate the credit markets and develop the commercial environment, the Government passed a bill in November 2015 to reform the regime of Insolvency and Bankruptcy.
The Insolvency and Bankruptcy Code of 2016 came with this bill.
Under the Insolvency and Bankruptcy Code of 2016, Insolvency indicates a situation of an entity facing financial hardships due to a lack of funds and assets. Both individuals and organizations can get insolvent, and it is a situation in which assets are of less value than liabilities.
Insolvency may get declared as bankruptcy by the court. A state of Insolvency occurs from an incapability to pay debts due to a lack of cash flow.
What is Bankruptcy under the Insolvency and Bankruptcy Code, 2016?
Bankruptcy under the Insolvency and Bankruptcy code of 2016 is a legal step taken when an individual or company cannot repay due debts.
The legal proceedings start with filing a petition under Provincial Insolvency Act by the insolvent. It is the last chance or final choice for the insolvent if they fail to repay their debts.
Even though bankruptcy provides a fresh start for an insolvent entity, it damages the credit rating and makes it hard for future loans and borrowings.
How Can I Save My Business from the Brink of Either Bankruptcy or Insolvency?
Steps you can take to protect your business from getting either insolvent or bankrupt are:
Monitor and Manage Your Cash Flow
Cash flow is the cycle of money in terms of revenue and expenses.
Many startups and businesses ignore keeping their cash flow in order which may be harmful in the long run. Make sure you have an accountant to track and manage the business’s cash flow.
It is perfect if you curate this in your company’s budget at the beginning, but don’t hesitate if you are thinking about this later on.
Cash flow will help you forecast the future of your financial and business conditions.
Manage your cash flow:
- By reducing expenses, keeping them minimal.
- Find the unimportant expenses that don’t contribute to business growth.
- Locate the areas where you can lower expenditures for essentialities.
Sell Assets You Can Bestow on to Lose.
There is no debate that money is what runs a business. You may have many assets or partners/clients, but that won’t pay for your food, clothing or other daily essentials. To keep your company in business, you would need money.
Your extravagant office and the latest technology in your company office may lure clients, but you may lose all of them if you get insolvent.
So, along with managing your cash flows, sell the assets you can afford to lose, and help you in financial hardships too.
Prioritize Your Essential Expenditures
Prioritizing your expenses will help keep your company alive, even during Insolvency. Make payments for the essentials that will keep your business running on a priority basis. Utilities like electricity, water, etc., are essentials.
Merge your Debts into One Loan if Possible
Try consolidating all your debts and obligations into one loan if you can. It will help lower the number of repayments to one and make it inaccessible to keep checks on your financial conditions.
Renegotiate Contracts with Partners
When companies do partnerships in businesses, they agree to the terms and conditions and make a signed contract for the trade deal. You may think that signed contracts are inflexible and cannot get negotiated again. But that’s not true. Many companies have renegotiated their signed contracts according to the circumstances.
If you are in financial distress, fix a meeting with your trade partner and ask if they are ready to negotiate the terms again.
If the trade partner has been happy to do business with you, they will get ready to renegotiate the terms, as they’ll be willing to keep working with your company.
In the case of large and complicated contracts, you may need to seek expert legal advice.
Make Contracts of Shorter Duration
Making contracts for a year can be beneficial, and it will provide a routine opportunity to re-evaluate and renegotiate trade deals.
All the above methods you can take to prevent your business from getting insolvent or bankrupt. Manage your funds and expenses wisely if you have become insolvent already. Seek legal advice from an expert corporate lawyer with in-depth knowledge of corporate law to assist you if you need to file for bankruptcy.