Insolvency vs Bankruptcy

Updated on March 27, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Differences Between Insolvency and Bankruptcy

Insolvency can be defined as a circumstance when the assets of an individual or a business organization are insufficient compared to the liabilities owned by the same. On the other hand, bankruptcy is a legal way of handling insolvency. An insolvent individual or business organization can help the government settle its dues lying with the creditors.

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Insolvency vs Bankruptcy Infographics

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Key Differences Insolvency vs Bankruptcy

Comparison of Table

Basis of Comparison Insolvency Bankruptcy
DefinitionIt is a disturbance in the financial well-being of an individual or a business organization when an individual or entity cannot meet the underlying financial debt obligations.It can be defined as the legal status of an individual or an entity that cannot repay the financial debts to the creditors, suppliers, and vendors.
Types
Corporate insolvency can be of three types: –

1) Voluntary administration- in this type of insolvency, the directors of an insolvent business organization appoint a voluntary administrator to investigate the affairs of the same.
2) Winding up or liquidationLiquidationLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order.read more – It is the winding up of a company by selling all the remaining assets of an entity and distributing the net proceeds amongst the creditors. If there is any surplus, the same is distributed to the equity holders.
3) Receivership- A type of insolvency where the secured creditors of a company appoint a receiver for selling the remaining assets and repaying their pending amounts.
Bankruptcy can be of two types: –
1) Reorganization bankruptcy- Restructuring of repayment plans is done in this type of bankruptcy.
2) Liquidation bankruptcy- In this type of bankruptcy, the debtors sell off their assets to pay their debts.

Financial StateIt is a financial state.It is not an economic state.
LegalityIt does not reflect the legal status of an individual or a business organization.It reflects the legal status of an individual or a company. Therefore, it is a lawful procedure used for helping insolvent individuals or business organizations.
How to Resolve?One can resolve it through bankruptcy and various other mechanisms.It can be determined by either winding up or taking the government’s help to settle their pending dues to the creditors.
Impact on Credit RatingsIt does not impact the credit ratings of an individual or a business organization.It does have a possible effect on the credit ratings of an individual or a business organization.
BehaviorIt is not permanent, i.e., it is a temporary state.It is permanent.
ProcessThe insolvency of an individual or a business organization is involuntary.The bankruptcy of an individual or a business organization can either be voluntary or involuntary.
IndicatorsThe indicators of insolvency of an individual or a business organization can be a rise in debts and liabilities, a drop in sales, liquidity ratios (current ratioCurrent RatioThe current ratio is a liquidity ratio that measures how efficiently a company can repay it' short-term loans within a year. Current ratio = current assets/current liabilities read more, quick ratio, etc.), being lesser than one, delay in payments, enhanced reliance on credit, etc.The indicators of bankruptcy are insolvency.
RelevanceIt is related to financial debt obligations.It is associated with the lawful or legal concept.

Conclusion

Insolvency can be defined as the failure of a person or business organization to pay off their financial debt obligations due to insufficient funds and assets. In contrast, bankruptcy is a legal way of handling insolvency. An insolvent knocks the government for help settling off all its dues and liabilities that the same owes to its creditors. Corporate insolvency is of three types- voluntary administration, winding up or liquidation, and receivership, whereas bankruptcy has two kinds- reorganization bankruptcy and liquidation bankruptcy.

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