A financial difficulty (mainly related to cash flows) that renders an entity (or a natural person) unable to meet debt payments and other requirements on a timely basis or when a need arises. For example, when a business is unable to pay its bill on time (as per contract or agreement), it is said to be insolvent. Insolvency is a sign of financial distress that, if not remedied on time, may exacerbate, turning into a dead-end situation where bankruptcy has to be declared. Bankruptcy, itself a state of insolvency that takes different trajectory, is a legal process that happens when a person is declared by a court of law (bankruptcy court) unable to pay back its debts to creditors and creditor-like counterparties.
In accounting, there are two types of insolvency: cash-flow insolvency and balance-sheet insolvency.
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