Insolvency vs Bankruptcy

Publication Date :

10 Nov, 2020

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Table Of Contents

Differences Between Insolvency and Bankruptcy

Insolvency can be defined as a circumstance when the assets of an individual or a business organization are insufficient compared to the liabilities owned by the same. On the other hand, bankruptcy is a legal way of handling insolvency. An insolvent individual or business organization can help the government settle its dues lying with the creditors.

Differences Between Insolvency and Bankruptcy

Insolvency vs Bankruptcy Infographics

Key Differences Insolvency vs Bankruptcy

Insolvency can be learned as a person's financial state or a business organization when the real assets owned fall short of the liabilities owed to the creditors. In contrast, bankruptcy is a legal procedure through which an insolvent can take the government's help for the payment and final settlement of his financial debt obligations. A bankruptcy cannot take place before insolvency. After being confirmed that the same is facing ruin, an individual or a company 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. 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. Therefore, the insolvency of an individual or a business organization may not impact their credit ratings, whereas bankruptcy can affect 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. In this context, we can say that most insolvent companies cannot be declared bankrupt, whereas all bankrupt companies bear insolvency status.
An insolvent can avoid the possibility of bankruptcy by acting on time and designing and implementing adequate strategies that would resonate with the current requirements, dragging the same out of the insolvency phase. Insolvency may not necessarily be followed by bankruptcy since there are other mechanisms through which an insolvent can deal with insolvency, whereas bankruptcy can only occur after insolvency.

Comparison of Table

Basis of Comparison	Insolvency	Bankruptcy
Definition	It is a disturbance in the financial well-being of an individual or a business organization when an individual or entity cannot meet the underlying financial debt obligations.	It can be defined as the legal status of an individual or an entity that cannot repay the financial debts 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 liquidation - 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. If there is any surplus, the same is distributed to the equity holders. 3) Receivership- A type of insolvency where the secured creditors of a company appoint a receiver for selling the remaining assets and repaying their pending amounts.	Bankruptcy can be of two types: - 1) Reorganization bankruptcy- Restructuring of repayment plans is done in this type of bankruptcy. 2) Liquidation bankruptcy- In this type of bankruptcy, the debtors sell off their assets to pay their debts.
Financial State	It is a financial state.	It is not an economic state.
Legality	It does not reflect the legal status of an individual or a business organization.	It reflects the legal status of an individual or a company. Therefore, it is a lawful procedure used for helping insolvent individuals or business organizations.
How to Resolve?	One can resolve it through bankruptcy and various other mechanisms.	It can be determined by either winding up or taking the government's help to settle their pending dues to the creditors.
Impact on Credit Ratings	It does not impact the credit ratings of an individual or a business organization.	It does have a possible effect on the credit ratings of an individual or a business organization.
Behavior	It is not permanent, i.e., it is a temporary state.	It is permanent.
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 ratio, 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 associated with the lawful or legal concept.

Conclusion

Insolvency can be defined as the failure of a person or business organization to pay off their financial debt obligations due to insufficient funds and assets. In contrast, bankruptcy is a legal way of handling insolvency. An insolvent knocks the government for help settling off all its 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 has two kinds- reorganization bankruptcy and liquidation bankruptcy.