A business or individual is insolvent when it is unable to pay its debts as they fall due, or when the total of its liabilities is greater than the total of its assets. Accountants and lawyers usually distinguish two tests: cash-flow insolvency, which looks at whether bills can be paid on time, and balance-sheet insolvency, which compares what is owned with what is owed.
How insolvent relates to the insolvency entry
The legal processes that can follow, such as administration, liquidation and bankruptcy, are covered in the main entry on insolvency and in the entry on bankruptcy. In accounting terms, balance-sheet insolvency shows up as negative equity on the balance sheet. For example, a company with assets of $4 million and liabilities of $5 million has a $1 million deficit and is balance-sheet insolvent, even if it can still pay this month's bills. Cash-flow insolvency is judged with measures such as the current ratio and cash forecasts: a company with $200,000 of cash and $900,000 of debts due next month is in trouble even if its assets on paper exceed its liabilities. Either kind of insolvency is a strong warning sign for auditors assessing whether the business is still a going concern, and for directors, whose duties may shift toward protecting creditors once a company becomes insolvent.