Insolvency is a major concern for business owners. When liabilities exceed assets, a company risks financial failure. However, with the right strategies, businesses can avoid insolvency and ensure long-term success.
What Is Insolvency?
A business becomes insolvent when it cannot pay its debts. This happens when liabilities are greater than assets. Sometimes, businesses face temporary insolvency. This occurs when cash flow is low, but the company can recover. However, permanent insolvency happens when a business lacks enough assets to cover its liabilities. If this continues, the business may go bankrupt.
Common Causes of Insolvency
Understanding what leads to insolvency can help businesses prevent it. The three main reasons businesses become insolvent are:
- Over-Trading – Expanding too fast without enough working capital.
- Over-Leverage – Taking on too much debt compared to assets.
- Over-Borrowing – Relying too much on loans instead of profits.
Long-term financial stability depends on managing these factors effectively.
How to Protect Your Business from Insolvency
To maintain financial health, businesses must follow strategic financial management. Here are essential steps to avoid insolvency:
1. Know Your Loan Capacity
Taking on loans without proper planning leads to financial trouble. Before borrowing, calculate your repayment ability. Use this formula:
Total Income – Total Expenses = Available Amount (-) Compulsory Saving
The remaining amount determines your ability to repay loans without financial stress.
2. Never Borrow More Than Your Asset Value
Your loan amount should not exceed your total assets. If you borrow too much, your business may struggle to recover. Always align loans with business growth and revenue.
3. Keep Interest Payments Within Total Inflow
Interest payments should never exceed your cash inflow. If interest payments become unmanageable, take corrective action. Selling investments and reducing debt can help ease financial pressure.
Take Action to Secure Your Business
To build a financially strong business, focus on cash flow management, strategic borrowing, and efficient resource allocation. Avoid unnecessary risks and monitor financial health regularly. By following these steps, businesses can stay solvent and continue to grow successfully.
