When should a company file for bankruptcy?
What makes a company file for bankruptcy?
Usually, a company files for bankruptcy because it cannot pay its debts. According to the US Bankruptcy Code, there are two ways to tackle this.
Types of bankruptcies for businesses:
Why would filing for bankruptcy be beneficial for a company?
Potential benefits of filing for business bankruptcy include:
- Reduction or elimination of unsecured debts
- Return to profitability
- Debt consolidation
- Opportunity for improval in operating standards
- Chance to attract investors
What are the tell-tale signs of a company ready for bankruptcy?
Whatever your role within the company, it’s wise to keep an eye out for the following signs the business might be headed for bankruptcy:
- Delaying the payment of bills
- Rapid and sometimes inexplicable managerial turnover
- Losing a large lawsuit
- Receiving large fines by a regulatory authority
- A stable and successful competitor has entered the market
- A competing product is making gains in the marketplace
- Majorly downtrending stock price
- Bankruptcy rumors
- Abandonment by institutional investors
When should a company file for bankruptcy?
So, exactly when should a company file for bankruptcy? It’s important to act without delay if your business is starting to see signs of insolvency. You might be experiencing the following:
Balance sheet insolvency (technical insolvency)
Sit down and list all your company assets in one column and your liabilities in the other. When you add it all up, if the value of your assets is less than that of your liabilities, your business is insolvent. The aim of this test is to determine whether the company could pay its creditors if some assets were sold.
Cash flow insolvency (commercial insolvency)
The cash flow test is the more prominent of the two. It requires you to cross-check your working capital against your forecasted sales and payments, without relying on assets that could potentially be sold.
When a business fails either one of the above tests, it’s time to file for bankruptcy. The question is whether you want to continue trading and file under chapter 11, or simply liquidate and wind up the business under chapter 7.
Unlike in the US, insolvent companies in the UK do not file for “bankruptcy”. Instead, they usually enlist the help of an insolvency practitioner to negotiate with creditors, or put the company into “administration”.
If your small business is in Australia, there are new provisions that allow you to negotiate with creditors and undertake debt restructure while continuing to trade.
Learn more: Safe Harbour Insolvent Trading