Insolvency vs Liquidation – What is the difference and how can it affect your business?
Insolvency and liquidation are related but distinct concepts in accounting and law. The main difference between the two is that insolvency is a state that your business could be in, whereas liquidation is the process of dissolving the company to resolve the financial stress.
At BRI – Business Recovery and Insolvency, we are on hand to become your trusted partner when it comes to understanding insolvency and liquidation. If you require support, please contact our team today.
Insolvency meaning
Section 123 of the Insolvency Act contains the technical definitions of ‘insolvency’ but broadly speaking it is when a corporate entity, or individual, cannot meet their financial obligations. This can often be assessed in two ways:
- Cash flow test: when a company/individual cannot pay their debts as they fall due.
- Balance sheet test: when a company’s/individual’s liabilities exceed their assets.
Liquidation meaning
Liquidation, on the other hand, is the name given to a formal process of winding up a company’s affairs, realising its assets, and distributing the proceeds to creditors (an equivalent process for an individual is called bankruptcy).
Liquidation typically occurs after a business has become insolvent and is instigated one of two way.
- By the directors, normally via a voluntary liquidation, in which the directors engage with an insolvency practitioner who assists them with the process of placing the company into liquidation. This involves holding a board meeting and a shareholder meeting to agree to the winding up and appointment of a liquidator, and a decision procedure of creditors to ratify the appointment.
- By a creditor of the company, normally resulting in a compulsory liquidation, whereby the creditor petitions to Court for the winding up of the company.
Insolvency vs Liquidation – what‘s the purpose of liquidation?
Whether the liquidation is voluntary or Court led, the purpose of the liquidation is for the insolvency of the Company to be formally recognised and liquidator(s) to be appointed. The directors lose their powers following the date of liquidation and the liquidators take control of the company in order to realise assets, investigate the conduct of the directors and distribute surplus funds to creditors.
Alternatives to liquidation
Insolvency can lead to various outcomes in addition to liquidation. Other formally recognised procedures include a Company Voluntary Arrangement and Administration. There are also informal options, such as restructuring the company’s operations, achieve payment plans with individual creditors, re-financing or obtaining further investment. All of these are alternatives to liquidation which have a primary objective of saving the business as a going concern, whereas liquidation results in the complete cessation of the business and is considered a ‘terminal’ process.
At BRI, we can help with any of the above mentioned processes. Please contact if you need any advice.
So, Insolvency vs Liquidation – what is the difference?
The key difference with the terms is that insolvency is a state of financial distress, whilst liquidation is an action taken to resolve that distress.
Should you or a client consider that you are facing potential insolvency please do contact BRI Business Recovery and Insolvency in order that one of our experienced team can help you consider all the options that are available, not just liquidation.