oceedings or bankruptcy.
This is an accounting concept signifying that the book value of a firm's assets is less than its liabilities. It should be distinguished from so called 'cash-flow' insolvency, in which case a firm is unable to pay its debts as they fall due. Such inability may be inferred from the fact that a company has failed to pay, on demand, a debt which is due. Financial economists commonly use the expression 'financial distress' to refer to the condition experienced by a firm which is having difficulty in paying its creditors. Although there are some terminological differences between authors, the phrase is often used to refer to the condition of a firm which is in substantial default on its debt obligations.
To a far greater extent than the balance sheet test of insolvency, financial distress is dependent on the structure of the repayments under outstanding debt obligations, and the nature of the assets available to satisfy them. Illiquid assets and large repayments may mean that a firm which is solvent in a balance sheet sense cannot pay its debts as they fall due. Conversely, a firm which has significant growth opportunities and debt repayments spread over a number of years may be insolvent in a balance sheet sense, but nonetheless be able to pay its debt as they fall due.
3. Economic Distress
Solvency should be distinguished from economic viability. Insolvency is concerned with the relationship between a firm's assets or cash flows, and the amount of debt in its financial structure. Viability is a function of the net present value of its business as a going concern. Provided that the business has a going concern value which is greater than the value of its assets sold on a break-up basis, and also greater than zero, then it is economically viable. In other words, its assets are being put to their highest-valued use.
Lack of economic viability is referred to as economic distress.3 This condition is related to financial distress in the following way: all firms which are economically distressed will also become financially distressed. The reverse, however, is not true. A firm with an economically viable business may become financially distressed simply because it has taken on more debt than it can service.
The terms 'liquidation' and 'reorganization' are used to refer to the outcomes of financial distress. Liquidation in the sense used here refers simply to the conversion into cash, through sale, of a