Insolvency – Detection
Insolvency refers to the inability to pay bills in a timely manner. It does not mean bankruptcy but long-term insolvency is an underlying factor of bankruptcy. Many owners and/or managers of small business have no idea of how to determine if the company is insolvent or headed towards the inability to meet their day-to-day obligations. This article is designed to assist the reader in understanding how to detect actual insolvency or identify potential insolvency.
Prior to reading this article, please be sure to read the introductory article: Insolvency and Bankruptcy – Know the Difference as it is a great lead in to the more sophisticated information provided here. There are several links throughout this article to assist the reader in understanding other elements of insolvency. If you are having trouble understanding some of the formulas, please refer to the material linked to help you.
This article will first teach you about the basic tools used to detect insolvency. Other articles on this site will explain this in more detail using trend lines to evaluate a company’s ability to pay its current liabilities. Finally, I will explain some tricks and nuances related to insolvency so that you have a well informed position of knowledge related to insolvency.
Insolvency – Basic Tools of Detection
There is one tenet of insolvency the reader must remember and keep in their mind at all times. Insolvency is an extended time period and not a single moment in time. In effect, it takes several months to become insolvent and rarely does it exist for a short duration, such as one or two days. Again, insolvency extends over a long period of time, at least two months and often over many months (more than six). Given this, the tools to test for insolvency must be exercised over time, and
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