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Differences Between Insolvency and Bankruptcy
Insolvency can be defined as a circumstance when the assets of an individual or a business organization are insufficient in comparison to the liabilities owned by the same. On the other hand, Bankruptcy is a legal way of handling insolvency, wherein an insolvent individual or business organization can take help from the government for settling off his dues lying with the creditors.
Insolvency vs Bankruptcy Infographics
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Key Differences Insolvency vs Bankruptcy
- InsolvencyInsolvencyInsolvency is when the company fails to fulfill its financial obligations like debt repayment or inability to pay off the current liabilities. Such financial distress usually occurs when the entity runs into a loss or cannot generate sufficient cash flow.read more can be learned as a financial state of a person or a business organization when the actual assets owned fall short of the liabilities that are owed to the creditors. In contrast, bankruptcy is a legal procedure through which an insolvent can take the help of the government for the payment and final settlement of his financial debt obligations. A bankruptcy cannot take place before insolvency. An individual or a company after being confirmed that the same is facing insolvency can opt for various mechanisms to deal with the ongoing dark phase. Bankruptcy is one of those mechanisms that can be preferred by an insolvent. Bankruptcy is permanent, whereas insolvency is temporary in nature. Insolvency is involuntary whereas bankruptcy can either be voluntary or involuntary.
- Bankruptcy is a legal procedure for resolving insolvency, whereas the latter is merely a financial state. Insolvency of an individual or a business organization may not impact their credit ratingsCredit RatingsCredit rating process is the process in which a credit rating agency (preferably third party) analyzes a security and rates it accordingly so that the stakeholders can make their investing decisions.read more, whereas bankruptcy can impact their credit ratings. Sudden rise in debt obligations, significant fall in sales, liquidity ratios below one, increased reliance on credit, delay in payments, lesser profits, etc. are the indicators of insolvency of an individual or a business organization. However, the indicator of bankruptcy is insolvency since it is the first stage of the same. In this context, it can be said that most of all the insolvent companies cannot be declared bankrupt, whereas all bankrupt companies bear the status of insolvency.
- An insolvent can avoid the possibilities of bankruptcy by acting on time and designing and implementing adequate strategies that would resonate with the current requirements and drag the same out of the insolvency phase. Insolvency may not necessarily be followed by bankruptcy since there are various other mechanisms through which an insolvent can deal with insolvency whereas bankruptcy can only take place after insolvency.
Comparison of Table
| Basis of Comparison | Insolvency | Bankruptcy |
|---|---|---|
| Definition | This is a disturbance in the financial wellbeing of an individual or a business organization. It takes place when an individual or an entity is incapable of meeting the underlying financial debt obligations. | This can be defined as the legal status of an individual or an entity that is unable to repay the financial debts it owes 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. In case there is any surplus, then the same is distributed to the equity holders. 3) Receivership- It is a type of insolvency where the secured creditors of a company appoint a receiver for selling the remaining assets of the same and repaying their pending amounts. | Bankruptcy can be of two types- 1) Reorganization bankruptcy- In this type of bankruptcy, restructuring of repayment plans is done. 2) Liquidation bankruptcy- In this type of bankruptcy, the debtors choose to sell off their assets for paying the debts of the creditors. |
| Financial State | It is a financial state. | This is not a financial state. |
| Legality | It does not reflect the legal status of an individual or a business organization. | This reflects the legal status of an individual or a company. It is a legal procedure used for helping insolvent individuals or business organizations. |
| How to Resolve? | It can be resolved through bankruptcy and various other mechanisms. | It can be resolved by either winding up or taking the help from the government for settling their pending dues to the creditors. |
| Impact on Credit Ratings | It does not have any impact on the credit ratings of an individual or a business organization. | It does have a possible impact on credit ratings of an individual or a business organization. |
| Behaviour | This is not permanent in nature, i.e. it’s a temporary state. | It is permanent in nature. |
| Process | The 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. |
| Indicators | The 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. |
| Relevance | It is related to financial debt obligations. | It is related to the lawful or legal concept. |
Conclusion
Insolvency can be defined as the failure of a person or business organization in paying off their financial debt obligations as a result of insufficient funds and assets. In contrast, bankruptcy is a legal way of handling insolvency where an insolvent knocks the government for help concerning settling off all his 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 are of two types- reorganization bankruptcy vs liquidation bankruptcy.
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