For example, a business owner might spend time and money developing a product that she believes in without surveying customers and studying production costs to gauge whether the product could be profitable.
Even if the product is useful, it might not be financially viable from a business standpoint. Lack of education and experience in finance and management can increase the likelihood of poor decisions, but no company is immune to making mistakes.
Bankruptcy can result from a host of other underlying problems that inhibit profitability. Some other factors that can contribute to bankruptcy include poor business location, loss of key employees, lawsuits raised by competitors and personal issues like illness or divorce. Unforeseen disasters and criminal activity like floods, storms, fires, theft and fraud can also cause hardships that lead to bankruptcy.
Gregory Hamel has been a writer since September and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming. You know if you tried to sell equipment, you would take a loss, because it has depreciated.
If you are liquid, you have enough assets in cash to be able to pay your immediate bills or pay your employees. Most businesses don't have a lot of extra cash sitting around, but they should be able to know that they have enough, from revenue or selling stuff, to pay bills as they come due.
This is called a positive cash flow , and it means liquidity. The principle of solvency is related to liquidity, but it is a little broader. If a business is solvent it has enough assets to cover its liabilities. If all of the creditors of the business called in their loans and demanded payment kind of like a 'run on the bank' for a business , the business would have to sell or dispose of current assets, at a loss.
Solvency is measured with a business ratio called the "current ratio" which compares current assets receivables, supplies, and inventory to current liabilities those debts you owe that are due within the next year, like your taxes, payroll taxes, and monthly payments on your business loan.
The "current ratio" is supposed to be That is, the value of your current assets should be twice the amount of your current liabilities. As mentioned above, it is difficult to sell off assets quickly without taking some loss, so you need more assets to cover your liabilities. Solvency, then, is the ability of a business to maintain a current ratio of , so it can handle emergencies and pay its bills over the short term under a year.
The concept of viability is often discussed with living beings newborn babies, for example and their ability not only to survive but to thrive. Economic viability means continuing sustainable profits for a business over a period of time. It doesn't mean that every quarter is profitable, but that over time the business is profitable, which provides for liquidity for emergencies and solvency for current needs.
Remember that a business can be profitable without a lot of cash. Profits are just on paper; cash is in the bank. To explain, Corporate Law mandates that the shareholders are to be paid the last and those holding debt must be paid before them. Moreover, the shareholders also are paid only when there is money left over when compared to those who hold debt and debentures.
In addition, the focus of the laws is on ensuring that the assets are disposed off or are transferred to the new owners and in turn, helping those who hold debt recovers their money in the process.
Further, there are no explicit guarantees in the law to protect the employees specifically though there are provisions for a fair disposal of assets and paying dues to them.
Thus, the point we are making is that shareholders and employees must do their due diligence before investing or joining businesses. On the other hand, bankruptcies when handled well can rejuvenate the businesses and help former promoters to regain their footing. Upon examining the Indian Aviation Sector which is a classic case study on how bankruptcies can turn messy as well as result in happy turnarounds, we find that the Kingfisher Case is an example of how bankruptcies can turn real messy if they are not handled.
The case is dragging on since the last decade with no end in sight for the beleaguered creditors or the former employees while the erstwhile promoter lives it up abroad.
On the other hand, the case of Spice Jet is an example of how acute financial distress can be handled well and the firms turned around. Somewhere in the middle is the case of Jet Airways which seems to be moving towards some sort of resolution after a protracted struggle to tide over the crisis. Some experts opine that the IBC or the Insolvency and Bankruptcy code passed by Parliament is a response to criticism and media outrage after the cases mentioned above and other such cases which spurred the government into taking action.
As can be seen from the preceding discussion, bankruptcies can be occasions for both rejuvenation as well as relapse and hence, there is a need to handle them well without losing sight of the larger goal of ensuring justice to all stakeholders.
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