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The Two Types of Insolvency

April 29th, 2012 Posted in Legal Services

The legal term “insolvent” is a frequently misunderstood word because it encompasses two separate concepts which are uniquely different from one another. Although there are many financial states and conditions which are intentionally designed to be vague so that there is some wiggle room for financial freedom, the status of a company or corporation being insolvent is clearly designated and defined by the United Kingdom’s Insolvency Act 1986. This act clearly defines the true state of when a company or corporation is actually insolvent and also supplies the legal processes and jurisdiction of the law as well. Unfortunately, because of the complexity of this act as well as the legal term itself, the terms “insolvent” and “insolvency” are widely confused by the general public and sometimes even by the companies who find themselves in such a financial position. Understanding the two different types of insolvency can be quite beneficial in realizing what necessary processes and actions a company must undergo when they actually become insolvent.

When a company is insolvent it simply means that they theoretically are not acquiring enough funds to properly pay their due bills. The term used in this sense is quite general and very corporal. The two states of insolvency are known as cash flow and balance sheet and both terms are unique from one another. Cash flow insolvency is when a company just does not have the actual cash or credit to pay off their debts while balance sheet insolvency means that their umbrella value exceeds the amount of the debt they need to pay off. It is indeed possible for a company to be cash flow insolvent but not balance sheet insolvent and vice versa as well. When a company or corporation facing these dire situations understands the difference between the two types of insolvency they can have a lot more financial freedom to make effective plans to pay off their debt.

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