Henry Dachowitz writes:

Subject: Bankruptcy vs. Insolvency

This article is inaccurate.

The author states that basically companies become insolvent while individuals go bankrupt. I respectfully disagree -- both companies and individuals can either go bankrupt or become insolvent or both.

Bankruptcy relates to the Balance Sheet (Statement of Assets, Liabilities & Equity). It occurs when one's liabilities exceed their assets. The bankrupt individual or company can voluntarily declare bankruptcy or the creditors can force the entity into bankruptcy. Then a court-managed process ensues to marshal assets, pay off debtors, and possibly reorganize the entity's finances. Some debts may be discharged in part or full.

Insolvency relates to cash flow. It is literally a shortage of cash which prevents the insolvent company or individual from paying their debts as they come due. The total assets may exceed total liabilities, but the short-term assets are exceeded by the short-term liabilities.

For non-bankrupt entities, assuming all the assets will be realized for full value, then this insolvency is simply a timing issue; when the assets are converted into cash, the creditors can be paid off. However, if creditors insist on being paid when the debts are due, the debtor may have to liquidate their assets immediately; in this case of desperation or panic selling, those assets may only sell for a fraction of their true value when sold in the normal course of business (be they businesses' investments or an individual's home). This diminishment of value of the assets may throw an insolvent entity into bankruptcy.

In sum: individuals and company CFO's should ensure that TOTAL assets exceed TOTAL liabilities to avoid bankruptcy, and at the same time should ensure that SHORT-TERM assets exceed SHORT-TERM liabilities to avoid insolvency.