What is insolvency?

Definition of insolvency

Insolvency is a situation when a business (or an individual even) cannot pay its debts when they fall due. For example, a business has used credit to purchase goods but has no money to pay the bill when it is presented by the supplier of the goods.

Most businesses will fail to pay some their bills on time, at some point, but this does not mean they are insolvent. Failure to pay on time could be due to a poor administrative process, or there is a temporary staffing issue, or that records have been lost. Insolvency arises when the businesses debts far exceeds the actual cash and other liquid assets that it has.

Insufficient training in financial management

A business or organisation may become insolvent if directors, committee members and managers have insufficient training in accounting and finance. They may not be able to:

  1. Engage in appropriate budgeting processes that result in reliable predictions of future income, expenditure and profit.
  2. Identify threats to sources of income
  3. Detect over and unplanned expenditures
  4. Monitor variances between planned and actual financial outcomes
  5. Ensure full compliance with tax, gaming and other laws and as a result incur financial penalties for their organisations.

Failure to manage risks

A business or organisation may become insolvent if there is a failure to manage risks and suffer financial losses as a result of:

  1. Fraud and embezzlement by employees
  2. Thefts and fires which should have been covered by insurance
  3. Litigation for negligence

Changes in the business environment

A business or organisation may become insolvent if there is a failure to deal with changes in the business environment such as:

  1. Unfavourable long-term demographic changes that reduce the customer base i.e. the number of people joining as members
  2. Activities by competitor organisations that change market share i.e. offering new programs, improving facilities, engaging in promotion.
  3. Changes in legislation or government programs i.e. changes to important government funding sources.

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