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Insolvency is a legal term used to describe when a person or organisation is unable to meet its financial obligations. This can happen when a person or organisation does not have enough money to pay its debts or when a person’s or organisation’s income is not sufficient to cover its expenses. Insolvency can also occur when a person or organisation is unable to sell its assets to pay its debts.

What types of insolvency are there?

There are three laws for insolvency: bankruptcy, suspension of payments, and debt restructuring for individuals act. Companies with payment problems and outstanding debts can apply for bankruptcy or suspension of payments. Suspension of payments is granted by the court and gives companies room to put their affairs in order and avoid bankruptcy, often through an agreement with creditors. If the issues are too great, the company is declared bankrupt.

Bankruptcy through insolvency

There are several types of bankruptcy or insolvency procedures available in the UK, including:

  1. Bankruptcy: This is a formal insolvency procedure for individuals who cannot repay their debts. It involves the sale of the individual’s assets to pay off creditors and can last up to 12 months.
  2. Individual Voluntary Arrangement (IVA): This is a legally binding agreement between
    an individual and their creditors to repay a portion of their debts over a set period,
    usually five years. After this period, the remaining debt is typically written off.
  3. Debt Relief Order (DRO): This is a form of bankruptcy for individuals who have little to no assets, a low income, and debts under a certain threshold. It allows debts to be written off after 12 months.
  4. Company Voluntary Arrangement (CVA): This is a formal agreement between a company and its creditors to repay debts over a set period. It can help a company avoid liquidation or administration.
  5. Administration: This is a formal insolvency procedure for companies that are financially struggling but have the potential to be saved. An administrator is appointed to try to rescue the company or sell its assets to repay creditors.
  6. Liquidation: This is a formal insolvency procedure where a company’s assets are sold to repay its debts. There are two types of liquidation: compulsory liquidation, which is ordered by the court, and creditors’ voluntary liquidation, which is initiated by the company’s directors.

Preventing insolvency

Insolvency can be prevented by:

  • Regular financial management: Monitor your income and expenses, keep your
    accounts, and monitor your debts.
  • Proactive planning: Predict any financial problems and make plans to solve them before they get bigger.
  • Improve liquidity: Find ways to improve your cash flow, for example, by selling non-essential assets or finding new sources of funding. You can do this, for example, by outsourcing debtor management or opting for factoring.
  • Working with creditors: Hold regular meetings with creditors and work together to find a solution.
  • Consider insolvency treatment: If financial issues are unavoidable, consider in time the available options for insolvency treatment, such as suspension of payments or bankruptcy.

Signs of Potential Insolvency

Recognizing the early warning signs of potential insolvency is crucial for proactive financial management. Keep an eye out for the following indicators:

  • Increasing debt levels: Persistent and unmanageable growth in debt may indicate financial strain.
  • Declining profit margins: Shrinking profit margins over an extended period may signal financial instability.
  • Delayed payments to creditors: Consistent delays in payments to suppliers and creditors can be a red flag.
  • Cash flow issues: Difficulty in meeting day-to-day operational expenses may hint at liquidity problems.
  • Credit rating downgrades: Monitoring credit ratings is essential; downgrades may indicate perceived financial risk.
  • Legal actions and default notices: Receipt of legal notices or defaulting on contractual obligations may be precursors to insolvency.
  • Management and leadership changes: Frequent changes in leadership or management roles may suggest internal challenges.
  • Market challenges: Downturns in the market or industry-specific challenges can impact financial stability.

By staying vigilant and recognizing early signs of potential insolvency, businesses and individuals can proactively address underlying issues. Timely intervention is key to averting insolvency and ensuring a more resilient financial position. Employing a combination of financial management, strategic planning, liquidity enhancement, collaboration with creditors, and timely consideration of solvency treatment options creates a robust framework for preventing financial distress. Remember, the key to success lies in early detection and decisive action, allowing for the implementation of effective preventive measures. This approach not only safeguards against insolvency but also contributes to long-term financial stability.

This article has been revised by

Edmundas Volskis

Edmundas Volskis

Chief Risk Officer

Edmundas Volkis is a vital organization member responsible for identifying, assessing, and mitigating risks that could impact the company’s goals. In 2015, he was the first employee at Factris, besides the managing director.
Edmundas previously worked in data analysis and business consulting. The CRO deeply understands the organization’s business model, operations, risk appetite, and current and emerging risks that could affect the company.
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