Corporate bankruptcy means that the company is unable to pay its debts. According to data released by U.S. courts, over 22,000 companies go bankrupt each year from 2016 to 2020. This statistic does not include the number of small businesses that close their doors and abandon their failing operations.
What is Corporate Bankruptcy?
Corporate bankruptcy relates to debt. A company becomes bankrupt when it cannot pay its bills and there is no chance of acquiring more debt to settle them. Corporate bankruptcy is a process managed by U.S. bankruptcy courts that helps companies and individuals who cannot repay their debts get a fresh start.
Bankruptcy vs. Insolvency
Bankruptcy essentially involves a company’s inability to repay its debts, which is referred to as insolvency. A company’s ability to meet its obligations is linked to the concept of leverage, which is the ratio of a company’s debt to its assets. The higher the leverage, the greater the debt relative to the assets. For example, during the early years of the COVID-19 pandemic, bankruptcies were common among small businesses with high leverage.
Causes of Insolvency and Bankruptcy
There are many theories about the root causes of insolvency, business failure, and corporate bankruptcy, but most theories come down to three main reasons: poor management, inadequate marketing, and poor financial practices.
Many people enter a small business with technical knowledge in their field and management experience within corporations, but managing a small business is a different skill set. It requires wearing many different hats and addressing the demands of various groups (employees, customers, suppliers, regulators). In many cases, the failure of small businesses results from poor decisions made by their owners in management, marketing, and finance.
Poor decision-making early in a business often leads to a capital shortfall, meaning the company does not have enough assets, particularly cash, to operate daily. Not obtaining sufficient capital to start the business begins to create a spiral that is difficult to overcome, as the company accumulates more and more debt to secure working capital for daily operations and loans to purchase necessary assets.
Other Causes of Bankruptcy
The rate of bankruptcies in the United States can also be affected by external factors. For example, the number of bankruptcies dropped by around 30% in 2020 due to public access restrictions imposed by the courts during the first year of the COVID-19 pandemic.
Statistics related to bankruptcy filings can be misleading as they do not include the number of businesses that privately sell their assets and close their doors.
Some external factors that disrupt businesses and may lead to bankruptcy can include:
- Changing economic conditions, such as increased competition and rising business costs
- Personal issues, like illness or divorce
- Disasters, such as theft, natural disasters, or accidents
- Disputes with creditors or tax issues
Getting Help to Avoid Bankruptcy
If your company is facing difficulties, seek help from your bank, lawyer, and licensed tax professional to try to restore the situation. You may even want to consult a bankruptcy attorney to see if you qualify for bankruptcy.
Frequently Asked Questions
What happens to a company when it goes bankrupt?
The process of a company’s bankruptcy begins with filing a petition in the appropriate bankruptcy court. If the court approves the petition, the company starts the process of repaying creditors. It can involve liquidation by selling all of its assets to pay off creditors. It can also involve reorganizing the company under bankruptcy protection, laying out a plan to repay creditors while continuing operations.
Can a profitable company go bankrupt?
Although making a profit does not guarantee that your company will avoid bankruptcy, you can be profitable yet lack enough cash to pay your bills. For example, you may have high sales but also have a lot of accounts receivable—money owed to you by customers—and still need to pay your employees and suppliers, as well as repay loans taken out to purchase necessary materials. If your cash flow issues persist, you may need to incur more debt until you reach a point where you do not have enough cash to pay all your creditors. This situation can lead to business failure or bankruptcy.
Source:
https://www.thebalancemoney.com/why-do-businesses-go-bankrupt-a-crisis-of-liquidity-3974597
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