Insolvency is generally defined as a financial state in which a company can no longer pay its bills and other obligations on time. This occurs whenever liabilities, or debts, exceed assets and cash flow. Once a company becomes insolvent, it must take immediate action to generate cash and settle or renegotiate current debts. Companies which cannot successfully pull themselves out of this condition often face bankruptcy proceedings, receivership, or liquidation of all assets.
Commonly confused with bankruptcy, insolvency is not too dissimilar. Both conditions deal with liabilities exceeding assets, but insolvency is a state of being and bankruptcy is a matter of law. Companies can be insolvent but not legally bankrupt. Insolvency can lead to bankruptcy, but the condition may also be temporary and fixable without legal protection from creditors.
Companies facing the possibility of insolvency can take steps to keep themselves financially solvent. Using existing lines of credit to borrow money is one way to avoid it, but it also creates more liability and new payment deadlines. Selling off assets to other companies is also a common hedge against the condition. Consumers may notice a local grocery store changing hands, for example. The original grocery store chain may be approaching insolvency and selling off 30 or 40 of its local stores in order to generate immediate cash for timely debt repayment.
Another option for avoiding insolvency is acquisition by a larger corporation. It is not unusual for major conglomerates to seek out small but commercially viable companies for acquisition or takeover proceedings. Even if the smaller company is currently flirting with insolvency, the rights to its signature product lines may prove valuable enough to save it from financial ruin. This happens quite often in the wholesale food industry. Struggling manufacturers of a popular product may agree to sell off all of their assets to a corporation with better financing.
Insolvency does not necessarily lead to bankruptcy, but all bankrupt companies are also considered insolvent. Once an announcement of insolvency is made, stockholders may have to decide whether or not to sell off their shares or remain with the company until it can regain its financial footing.