If your company is in financial difficulty, the terms insolvency and liquidation often come up. Many directors use them interchangeably, but they’re not the same thing. Liquidation is a type of insolvency procedure, where insolvency is a financial state that means you’re unable to pay what you owe on time or in full.
What does insolvency mean?
Insolvency is a financial state. Your company is insolvent if it can’t pay its debts when they fall due, or if its liabilities outweigh its assets. There are two main tests for insolvency:
The cash-flow test – Can your company pay its bills on time and in full? If suppliers, staff or HMRC aren’t being paid as agreed, this indicates that your company might be insolvent.
The balance-sheet test – Do your liabilities exceed the value of your assets? If yes, then you’re technically insolvent, even if day-to-day bills are still being covered.
Being insolvent doesn’t automatically mean your company must close. There are several options to try and rescue or restructure the business, provided you act early enough.
What is liquidation?
Liquidation is a legal process that happens when a company closes down. Its assets are sold off (or “liquidated”) to repay creditors, and the company is formally dissolved. There are different types of liquidation:
Creditors’ Voluntary Liquidation (CVL) – Creditors’ Voluntary Liquidation is the most common type for insolvent companies. Directors make the proactive decision to close the business, handing control to a licensed insolvency practitioner who manages the closure.
Compulsory Liquidation – This is a liquidation forced by the court, usually when a creditor petitions because they haven’t been paid. Compulsory Liquidation is usually the last resort and could be avoided if the directors act quickly.
Members’ Voluntary Liquidation (MVL) – Used for solvent companies that want to close in a tax-efficient way. Members’ Voluntary Liquidation isn’t about debt but about winding up a company that’s no longer needed.
How insolvency and liquidation fit together
The easiest way to think of it is like this:
- Insolvency is the challenge you face if your company can’t pay its debts.
- Liquidation is one of the possible solutions and involves closing the company and selling any assets to pay off those debts.
Not every insolvent company goes straight to liquidation. If the business has potential to recover, there are rescue options. But if recovery isn’t realistic, liquidation becomes the best route forward.
What are the alternatives to liquidation?
If your company is insolvent but could still trade successfully with support, other insolvency solutions may be better than liquidation. Each of these aims to rescue the business, rather than close it.
Company Voluntary Arrangement (CVA) – A Company Voluntary Arrangement is a legal agreement made with creditors to pay debts back in affordable instalments, while you keep trading.
Administration – During an administration, a licensed insolvency practitioner takes control to work out a rescue or sale that keeps some or all of the business open, to protect jobs and creditors’ interests.
Negotiations with HMRC – If it’s tax debt that’s your biggest challenge, a structured repayment plan with HMRC – called a Time to Pay arrangement – could give you a manageable way to pay off your tax arrears.
When liquidation is the right option?
Liquidation is usually the right path when:
- Debts are unmanageable
- Creditors are threatening or have already started legal action
- There are no realistic prospects of the business becoming profitable again
- Continuing to trade risks directors being personally liable for wrongful trading
In these cases, liquidation draws a line under the situation. Debts are written off, directors meet their legal duties, and the stress of juggling unpayable bills comes to an end.
Why acting early matters
If you wait too long, you may lose the chance to save your company. Creditors can take matters into their own hands through a statutory demand or winding-up petition. Acting early means you can choose the best path for you, rather than having it forced on you.
We help directors understand whether their company is simply facing short-term pressure or whether liquidation is the best option. Either way, you’ll get clear advice about your duties, your risks, and your next step. Speak to a our expert advisers for early advice that gives you more control and more options.
