Insolvency

Insolvency

After a few years of very favourable economic conditions and dynamic growth even before the extraordinary situation caused by the COVID-19 pandemic occurred, the global and Polish economy began to slow down. More and more clear signals indicated that we are now in the phase of a cycle of economic slowdown – in Poland, the dynamics of gross domestic product growth has been regularly decreasing, both individual consumption and industrial activity has been decreasing, while the level of inflation has been systematically rising. This situation has been aggravated by the instability of the global and domestic economy related to the coronavirus pandemic.

ANALYSIS OF FINANCIAL CONDITION

The current unfavorable situation caused by the COVID-19 pandemic has led to a significant economic slowdown and, in some sectors, to the almost complete cessation of business activities. Therefore, the ongoing monitoring and analysis of the company’s financial condition is extremely important from the entrepreneurs’ point of view.

In economic practice, three states can be distinguished, which define the condition of companies in relation to their level of solvency:

  • solvency,
  • threat of insolvency,
  • insolvency.

INSOLVENCY

The definition of a state of insolvency was included in article 11 of the Act of 28 February 2003. Bankruptcy Law (hereinafter: P.U.). The concept of an insolvent debtor should be understood from the perspective of two premises:

  • liquidity premise (short-term) – Article 11.1 of the Polish Commercial Companies Code, according to which an insolvent debtor is one that has lost the ability to perform its maturing monetary obligations;
  • debt premise (long-term) – art. 11 par. 2 P.U., according to which a debtor who is a legal person or an organizational unit without legal personality, which is granted legal capacity by a separate act, is also insolvent when its pecuniary liabilities exceed the value of its assets, and this state is maintained for a period exceeding twenty four months.

The occurrence of a state of insolvency of a company is not a situation that appears suddenly and unexpectedly. It may occur as a result of the coincidence of various circumstances negatively influencing the financial condition of the company, caused by both external and internal factors. These circumstances may cause, among others, a decrease in the level of operating income, worsening of profitability, increase in demand for working capital or prolonged period of receivables collection.

INSOLVENCY RISK

The risk of insolvency is related to the risk that the company may become insolvent in the future. A specific feature of the risk is the lack of certainty that it will actually be realised. For this reason, the entrepreneur should, with the help of appropriate tools, if necessary, substantiate the risk of insolvency before the court and the creditors. The definition of the risk of insolvency was formulated in the Act of 15 May 2015. Restructuring Law. In accordance with Article 6(3): “A debtor at risk of insolvency should be understood as a debtor whose economic situation indicates that he may soon become insolvent”.

ASSESSMENT OF THE CONDITION OF THE COMPANY

There are a number of tools proposed by practitioners, which allow to assess the financial, operational and resource condition of a company and provide conclusions on the occurrence of symptoms of insolvency risk. The most frequently indicated methods are indicator analysis and discriminatory analysis.

The use of indicator analysis and discriminative models in a company enables early detection of symptoms leading to the occurrence of the premises of insolvency, thanks to which the company can introduce appropriate corrective measures and eliminate potential dysfunctions at an early stage. On the other hand, if the entrepreneur anticipates reaching the state of insolvency in the nearest future, this state should be defined as a state of threat of insolvency, which should be connected with undertaking restructuring activities by the given entrepreneur.

Text written by CMT Advisory experts.

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