Everything you need to know about insolvency and its early detection

What is insolvency?

In principle, a company must have sufficient liquid assets to meet its payment obligations—this includes salaries, rent, liabilities, and invoices, among others. If a company cannot guarantee its solvency, or if another ground for insolvency exists, the company is at risk of insolvency. From this point on, the entrepreneur or managing director is legally obligated to file for insolvency proceedings.

The 3 grounds for insolvency

The so-called grounds for insolvency require managing directors to file for insolvency. The Insolvency Code distinguishes between general and specific grounds for insolvency. The general ground describes the state of illiquidity (§ 17 InsO). The term "general" means that illiquidity serves as a reason for opening proceedings regardless of the type of procedure or the debtor. Over-indebtedness (§ 19 InsO) is a specific ground for opening proceedings relevant to legal entities and equivalent legal bodies. In addition to these two, there is imminent illiquidity (§ 18 InsO) as a "voluntary" ground for insolvency, which allows the debtor to file an application voluntarily.

Illiquidity (§ 17 InsO)

Eine Zahlungsunfähigkeit besteht, wenn das Unternehmen den fälligen Zahlungspflichten nicht mehr nachkommen kann und voraussichtlich dauerhaft nicht fähig sein wird. Die Zahlungsunfähigkeit wird durch eine Gegenüberstellung von liquiden Mitteln und fälligen Verbindlichkeiten ermittelt (liquide Mittel/ fällige Verbindlichkeiten). Ist das Ergebnis aus dieser Berechnung kleiner als 0,9, also kleiner als 90%, spricht man von der Zahlungsunfähigkeit.

Subsequently, it is determined whether the company can resolve the illiquidity within the next three weeks. The calculation for this step is based on forecasts and is as follows: liquid assets + future incoming payments (three weeks) / due liabilities + liabilities becoming due (three weeks). If this quotient is also less than 0.9, i.e., less than 90%, then according to the Federal Court of Justice (BGH), illiquidity exists and an insolvency application must be filed.

Over-indebtedness (§ 19 InsO)

Insolvency-related over-indebtedness exists when there is a negative going-concern forecast and a mathematical over-indebtedness is determined via an over-indebtedness balance sheet. For the balance sheet, the status of over-indebtedness as well as the forecast regarding the continuation of this status must be prepared.

Imminent illiquidity (§ 18 InsO)

Imminent illiquidity occurs when the debtor is expected to be unable to meet their payment obligations in the future. It gives the debtor the sole right to file an early application for the opening of insolvency proceedings.

Obligations for the managing director

As part of their business activities, managing directors must fulfill heightened obligations regarding planning, monitoring, and control. This includes ensuring solvency through sufficient liquidity. In the event of illiquidity or over-indebtedness, entrepreneurs of a corporation (e.g., GmbH or AG) are obligated to file for insolvency; in the case of imminent illiquidity, there is the right to file for insolvency. According to § 15a InsO, if a ground for insolvency exists, insolvency proceedings must be applied for within three weeks. If entrepreneurs fail to fulfill this obligation, they are liable for prosecution for delaying insolvency.

Triggers for corporate insolvency

Insolvency can be triggered by many different factors. In most cases, however, insolvency cannot be attributed to a single trigger, but rather a combination of the following factors:

• Lack of or poor management in cash flow management, controlling, or accounting
• Decreased revenue due to external factors (such as restrictions from the COVID-19 pandemic) or internal developments (such as a lack of competitiveness)
• Deteriorated liquidity due to, for example, suboptimal invoice and receivables management
• Increased costs with stagnant revenue due to, for example, higher personnel or rental costs

Early detection through liquidity management

These triggers show that insolvency can threaten anyone whose control mechanisms are not functioning correctly. Declining sales coupled with rising costs should be a serious warning sign of negative trends for any entrepreneur. If the company still has sufficient liquid assets, these trends do not necessarily have to lead to insolvency. To assess the risk of impending insolvency, it is therefore important to always keep an eye on your own liquidity and be able to assess it accurately.

For this, functional and accurate liquidity planning and management are essential: costs must be strictly controlled and, if possible, reduced; outstanding receivables must be collected; and sales must be increased. Tidely enables precise and holistic liquidity planning, supporting the managing director as a central tool for crisis monitoring and management.

Tidely uses smart tools to show liquidity bottlenecks at a glance, as well as opportunities for securing and increasing liquidity. The option of a comprehensive real-time liquidity report displays the company's insolvency risk using an easy-to-understand traffic light system. Based on planned values, the radar compares current solvency with that of three weeks ahead, giving the entrepreneur the necessary foresight for future liquidity developments. A diligent monthly plan is required for the most accurate assessment possible. In this way, the insolvency radar acts as a feature for the early detection of impending insolvency and supports the entrepreneur in their business duties.

Always keep an overview of your finances with Tidely and identify the risk of impending insolvency early on thanks to intelligent planning mechanisms. Find out more about our liquidity management.