About 20% of small businesses fail within their first year. Several factors can lead to the closure of a business whether it’s a bad business model or bad timing.
A top reason why many businesses fail is because they can’t repay their debts. A failing business can’t meet its financial obligations.
When this happens to a business, the stakeholders must know how to respond. The goal is to try to pay back the debt to keep the business afloat.
There are two terms that apply to this area. Insolvency and bankruptcy. Read on to learn the difference between insolvency vs. bankruptcy.
What’s Insolvency?
Chances are you’ve heard the terms insolvency and bankruptcy. Both terms tend to come up when discussing debt. They often appear as synonyms, but this isn’t the case.
So what’s the difference between insolvency vs. bankruptcy? Well, insolvency refers to a state of financial distress. It occurs when a business can’t pay its debts.
A business that can’t repay its debts may be labeled “insolvent.” Think of it as a status that’s assigned to a business.
Several factors can lead to business insolvency. Inadequate accounting practices can lead to this state. Poor management is another factor, as is the case with rising vendor costs and lack of income.
How Does Insolvency Work?
Insolvency can lead to proceedings. This involves taking legal action against the business that owes money.
It also calls for the liquidation of assets, which is often done through a business closure auction. The money from the auction can then be used to pay off outstanding debts.
It’s common for business owners to contact their creditors to work out a repayment plan. This is an approach that most creditors accept as they seek to get their money paid to avoid major losses.
What’s Bankruptcy?
Bankruptcy is a legal declaration a business can make when it can’t repay any debts anymore. This can only take place if the business has been declared an insolvent business.
Under bankruptcy, a business becomes a debtor after filing a petition with the court. A creditor can’t refuse a debtor from going into bankruptcy as it’s legally bound to the process.
How Does Bankruptcy Work?
Declaring a business bankruptcy makes sense if a business wants to get a fresh start with its finances. A business will need to determine which type of bankruptcy it should file for.
The chosen bankruptcy filing allows a business to set up a payment plan and liquidate assets as needed. Certain debts can be forgiven under this process.
Understand the Difference Between Insolvency vs. Bankruptcy
Now that you know the difference between insolvency vs. bankruptcy, you can take the right steps to seek debt relief. If your business becomes insolvent, you can explore your options. Bankruptcy is an option you may want to consider if your business can’t pay its outstanding debts.
Make sure to explore the rest of our blog to continue reading more great articles.