What is insolvency?
Insolvency is a legal concept describing when a company cannot pay its debts on time and its payment problems are not judged to be temporary. To avoid bankruptcy, the company can apply for a company reorganisation, which gives the business a chance to restructure while claims are frozen. If the company does not manage to recover, bankruptcy is often the next step.
In practice, insolvency is often discovered when the company misses payments, receives records of non-payment or lacks the liquidity for its running costs. It is a clear sign that the finances are not holding up, and action must be taken quickly to try to save the business.
Signs of insolvency
Here are some common characteristics that make it easier to understand when a company is heading into insolvency or is already insolvent.
- Payments are missed
- A lasting lack of liquidity
- Debts cannot be settled
- Risk of reorganisation or bankruptcy
- Requires quick action
Once you know these signs, it becomes easier to judge how serious the situation is and what options the company has to get out of the crisis.
Risks & consequences of insolvency
Worth bearing in mind
When a company becomes insolvent, the risk increases considerably. It means that the company has lasting payment difficulties and cannot meet its financial obligations. As an investor, it is therefore important to follow what options the company has to turn the situation around, for example a reorganisation or a winding-up.
You should also be aware that shareholders often come last in line in the event of bankruptcy. This means that large parts of the investment, or all of it, may be lost. Clear communication, realistic action plans and insight into the company's liquidity are crucial for judging how serious the situation is.
Frequently asked questions
What causes insolvency?
Common causes are a lack of liquidity, high debts, weak sales or unforeseen costs that the company cannot handle.
How does insolvency differ from temporary payment problems?
Insolvency means that the problems are lasting and cannot be solved with short-term measures or temporary loans.
Can a company avoid bankruptcy if it is insolvent?
Yes. A reorganisation can give the company time to restructure the business and negotiate with creditors.
What happens to shareholders in an insolvency?
The risk is very high. In a bankruptcy, shareholders come last in order of priority and often lose their entire investment.
How can you tell that a company is heading towards insolvency?
Signs can include missed payments, delayed reports, liquidity problems and suppliers not being paid.