Liquidation or Insolvency, What’s the Difference?

Liquidation or insolvency

There’s a difference between liquidation and insolvency. In the UK both denote formal procedures for businesses when they experience financial issues. Liquidation means to shut down the business so that the business stops operating and sells its assets in order to pay its debts; insolvency means that a business goes into administration to help sort out its options to stay afloat.

Liquidation

Liquidation normally means that the business ceases trading and the assets are turned into cash to pay off any outstanding debts. The word liquidate sounds pretty final, but sometimes the business survives while the company is liquidated.

There are three types of liquidation:

  • creditors’ voluntary liquidation is where the company can’t pay its debts and creditors are involved when the director’s liquidate it;
  • compulsory liquidation is where the company can’t pay its debts and if may be that creditors apply to the courts to liquidate the company;
  • members’ voluntary liquidation is where the company can pay its debts but the owners/directors/shareholders wants to close it down

While the first two in the list above are used to wind up an insolvent company, the last, an MVL, is used to close down a solvent company that no longer has a purpose; or when the directors of a company want to realise the value of accumulated reserves in a tax-efficient way.

Administration / “insolvency”

Insolvency is the term used to describe a situation whereby a business is unable to meet its debts when they fall due, and/or when their liabilities exceed their assets. A business goes into administration to see whether anything can be worked out to save it from liquidation.

A company that is insolvent does not necessarily need to liquidate if it can be shown that there’s a future for the business to re-establish a reliable cash flow. Administration can help the business survive by protecting both the company and its assets from creditors while a restructure is worked out.

Although a business going into administration can mean that the business’s creditors lose out (often only getting so much in the pound for the money owed to them), normally going into administration is a better option than a compulsory liquidation for everyone involved.

Sometimes a business can be “cash insolvent” but have assets that exceed its debt. In this case it might be possible to find additional funds, but the members of the business will be required to “liquidate” their assets held in the business in order for it to meet its debts.

A business is “balance sheet” insolvent if its liabilities are greater than its assets.

Benefits of expert financial management

Businesses that enjoy expert financial management seldom find themselves in either of these two situations. Act fast is the motto! If a business is struggling financially it’s vital that it takes professional advice from an expert practitioner as soon as the first sign of problems, including issues with cash flow issues or pressure from suppliers. This is why it’s so important for business to stay on top of their bookkeeping and accounts, as early detection increases the options open to businesses.

About the Author: Sumit Agarwal
A specialist accountant and tax adviser for freelancers, contractors and small businesses since 2005, He is an expert in business growth and development strategies. A renowned tax expert for owner managed businesses and contractors, He won the British Business Forum’s Young Entrepreneur Award in September 2012, presented at the House of Commons by MP Vrinder Sharma.