An insolvent company is one that is unable to pay its debts as and when they fall due for payment. Trading whilst insolvent can lead to accusations of wrongful trading and the directors of the company can face personal liability for the debts of the company. It is therefore very important for all directors to be fully aware of their company’s financial position before incurring any new debts.

There are many causes of insolvency, including poor cash flow management and a reduction in cash inflow from the sales of goods and services to customers. Increased expenses can also contribute to insolvency, particularly when the increase is not fully recouped through increased income from increased sales of goods or services. Other reasons include a failure to evolve products and services to meet customer demand, loss of customers to competitors offering better or cheaper products, lawsuits against the business, and other factors.

Decoding Insolvent Companies: Definitions and Implications

The legal definition of insolvency includes a comparison of the company’s assets against its liabilities and a determination that the liabilities are greater than the value of the company’s assets at their present market values. Some authors have also suggested that a company becomes insolvent when it fails to reach its economic objectives in a socially constrained environment.

Once a company is determined to be insolvent the legal position of its directors changes and they must act in the interests of the company’s creditors rather than the shareholders. This shift in duties is what makes it important for directors to always understand their company’s financial position, especially when considering taking on new debts and putting the company through a process like Creditor’s Voluntary Liquidation.