Bankruptcy vs Insolvency – What’s the Difference and Does it Matter?

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Bankruptcy vs Insolvency

Most people use terms like “insolvency” and “bankruptcy” interchangeably, thinking it is the same thing. These terms are similar but not identical, as they have two meanings. This difference is important to understand as it could lead to different business outcomes. To start, insolvency is a state of financial being. It is reached when we cannot pay off our debts on time. On the other hand, bankruptcy is a legal process that resolves the issue of insolvency. Of course, a lot more goes into these definitions, and it varies from country to country, jurisdiction to jurisdiction.

Bankruptcy vs. Insolvency

Let’s go over all the concepts needed to comprehend the implications of bankruptcy and insolvency fully.


First, we will review the deeper meanings of the two terms. Insolvency is the state that could prompt one to file for bankruptcy. Anyone, a single person, a family, or an entire company can become insolvent when they cannot pay their lenders back on time. This state usually appears when the cash flow is lower than the cash going out for longer. For individuals, it means that their monthly income is lower than their monthly financial obligations. And for companies, it means that the cash flow the business generates combined with the assets it owns is less valuable than its liabilities. Insolvency is the state or step before bankruptcy. Usually, people or companies that become insolvent can take certain steps toward a constructive solution. One of those solutions, though not necessarily constructive, is bankruptcy.


Bankruptcy is a legal term. It is a legally binding declaration of an inability to pay off debts. When an entity, be it an individual or a business, files for bankruptcy, the obligation to pay off debts is not waived. Instead, said entity binds itself to pay off what is owed but with government aid. Generally speaking, there are two forms of bankruptcy, reorganization and liquidation. The first one restructures the debtor’s repayment plans to make them easier to meet. The latter forces debtors to sell assets (liquidate them) to pay the necessary amounts to creditors. These definitions are condensed in a nutshell. For any further information, contacting reputable insolvency services in Sydney is highly advisable as it can get quite technical and is very legally sensitive.

Balance sheet

Businesses use a balance sheet insolvency test to decide whether to stay afloat or file for bankruptcy. There are three factors that a business needs to consider to make a decision. The inflows, outflows, and assets all play a vital role, and their balance can determine the next course of action. A negative net asset is when the inflows are less than outflows, and the value of the assets is worth less than what is owed. Usually, it means that external aid is necessary to meet all the financial obligations.

On the other hand, if the company can sell some of the assets, it might attempt to cover the debts on its own. It does mean reducing the business operation overall and could entail an inability to continue working. It is not a very efficient way of going on about it. Financial advisors will conduct all the necessary reviews and make suggestion scenarios for reducing or outright eliminating debt. Creditors can be convinced that future cash flows will facilitate more room to breathe, financially speaking, in the future. But in that case, be ready to give a presentation.

Cash flow

An entity is cash flow insolvent when it cannot meet its financial obligations solely based on the lack of money. Not to be mistaken with foreseeing a more restrictive financial period. Cash flow insolvency only ensues when we cannot keep the lights on and pay other bills. Financial troubles and constraints are daily and do not fall under this category. Cash flow insolvency affects all entities, individuals, families, and businesses. Deciding on a further course of action is to take a cash-flow test. The debtor needs to evaluate current and future cash flows to determine if the projected income would be enough to cover all the expenses. This analysis will help us decide whether to push for a debt settlement or go and file for bankruptcy.

Economic and legal terms such as these can get confusing and have much more going on behind the curtains. However, now that we have a firmer grasp of what they constitute, we can make healthier and more constructive decisions for the future.

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