Insolvency means the inability to pay one's debts.

This is defined in two different ways:

Cash flow insolvency: unable to pay debts as they fall due;

Balance sheet insolvency: having negative net assets: liabilities exceed assets.

A business may be cash flow insolvent but balance sheet solvent if it holds illiquid assets, particularly against short term debt. Conversely, a business can have negative net assets showing on their balance sheet but still be cash flow solvent if ongoing revenue is able to meet debt obligations, and thus avoid default – for instance, if it holds long term debt.

Insolvency is not a synonym for bankruptcy, which is a determination of insolvency made by a court of law with resulting legal orders intended to resolve the insolvency.

Definition

Insolvency is defined both in terms of cash flow and in terms of balance sheet in the UK Insolvency Act 1986, Section 123, which reads in part:

123. Definition of inability to pay debts

(1) A company is deemed unable to pay its debts - ...

(e) if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due.

(2) A company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the company's assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.

Consequences of insolvency

The principal focus of modern insolvency legislation and business debt restructuring practices no longer rests on the liquidation and elimination of insolvent entities but on the remodeling of the financial and organizational structure of debtors experiencing financial distress so as to permit the rehabilitation and continuation of their business. In some jurisdictions, it is an offence under the insolvency laws for a corporation to continue in business while insolvent. In others, the business may continue under a declared protective arrangement while alternative options to achieve recovery are worked out.Fact: date=May 2008 Increasingly, legislatures have favoured alternatives to winding up companies for good.Fact: date=May 2008

It can be grounds for a civil action, or even an offence, to continue to pay some creditors in preference to other creditors once a state of insolvency is reached.Fact: date=May 2008

Debt restructuring

Out-of court debt restructurings, also known as workouts, are increasingly becoming a global reality. Debt restructurings are typically handled by professional insolvency and restructruing practitioners, and are usually less expensive and a preferrable alternative to bankruptcy.

Debt restructuring is a process that allows a private or public company - or a sovereign entity - facing cash flow problems and financial distress, to reduce and renegotiate its deliquent debts in order to improve or restore liquidity and rehabilitate so that it can continue its operations.