Insolvency vs illiquidity: What sets them apart?

Insolvency and illiquidity are two terms that are often used to describe a business that is experiencing cash flow problems or operational inefficiencies. However, both have very different meanings, which we will explore in more detail in this article. 

As a business owner, it’s important to have a clear understanding of these two terms and the differences between them so you can seek the right support to potentially eradicate the issues and get your business back on track and financially healthy. 

Let’s start by looking at what insolvency and illiquidity are. 

What is insolvency?

Insolvency is the term given to a business that can no longer meet its financial obligations, such as being unable to repay its debts on time. There are two types of insolvency: 

• Cash flow insolvency: when a business does not have the money to pay its debts when they are due, even if they sell their assets. 
• Balance sheet insolvency: this is when a business’s total liabilities or debts are greater than the value of its assets. 

If a business becomes insolvent, it is often a long-term financial issue, and it may have to go into liquidation, administration or restructuring to be able to repay its creditors. 

What is illiquidity? 

Illiquidity is often a short-term financial issue that is the result of a temporary poor cash flow rather than a long-term financial position. It is possible for a business to be illiquid but still remain solvent if the value of its assets are greater than the value of its debts. Illiquidity can occur when a business cannot access cash when needed, such as waiting for the sale of assets. 

Common causes of illiquidity include late payments from customers, not selling stock quickly enough, investing too much in equipment, or premises, or poor cash flow management. 

The key differences between insolvency and illiquidity 

Insolvency happens when a company can’t pay its debts, even if assets such as stock or equipment were sold. It’s a long-term financial crisis that often leads to restructuring, administration or liquidation.

Illiquidity, on the other hand, is a short-term cash shortage where a business possesses assets but finds it difficult to get hold of cash when it needs it, but it can be turned around with better cash flow management. As a more serious financial issue, Insolvency can lead to litigation, business closure and financial penalties.

Insolvent companies must liquidate assets or proceed with formal insolvency processes, while illiquid companies can generally recover through short-term borrowing, more efficient collection of receivables and enhanced financial planning. The primary difference is that insolvency suggests a deep-seated financial problem, while illiquidity is a short-term issue that can be resolved.

Does your business need insolvency or illiquidity advice?

If your business is experiencing financial difficulties and is either insolvent or illiquid, the team at Bridge Newland is here to help. 

Our business recovery and insolvency experts are on hand to take you through every step of the process, giving you peace of mind that the best outcome for your business will be achieved. Contact us today for tailored advice for your unique situation.

Categorised in: Latest Insolvency News, Liquidation News