What is the difference between insolvency and liquidation?

Insolvency describes a financial condition, while liquidation is a specific legal process. A company is insolvent when it cannot pay its debts as they fall due or when its liabilities exceed its assets. Insolvency may lead to a variety of outcomes, including restructuring through a CVA, entering administration, or negotiating with creditors. Liquidation, on the other hand, is the process of formally winding up a company and distributing its assets to creditors. Liquidation may be voluntary, when directors decide to close an insolvent company, or compulsory, when a court orders closure after a creditor petition. The two terms are often used interchangeably but have distinct meanings. Not all insolvent companies enter liquidation; some are rescued through restructuring. However, all companies in liquidation are insolvent, unless it is a members’ voluntary liquidation, which applies to solvent companies choosing to close for strategic reasons. Understanding the distinction helps directors choose the most appropriate course of action.