How to Avoid Bankruptcy and Insolvency of your BusinessComments Off
They often say no one is an island; denoting that no one is self sufficient and at one point in time, they need other people to lend them their hand. I would like to add that no business is self sustaining either. A business needs a number of players to operate smoothly. Now that a business is treated as a separate entity from its owner or owners, it has the legal capacity to enter into legal contracts with these players. It can also file a case or can be sued in its name. Some of the key players in any business are the financiers. These are people or organizations that finance the business. This financing is in form of loan advance.
Other important players in a business are creditors and debtors. Debtors are those people who have some money or valuables belonging to the business. Creditors are those people who the business has their cash. A business operates in a fixed cycle of time called accounting period. It is usually one year. At the end of this period a business calculates its liabilities and assets and balances them to determine its net worthiness. If the assets are more than the liabilities then the business is said to be financially healthy. If the liabilities are more than the assets, then the business is said to be insolvent; it is unable to meet its financial obligations.
Now this is a very dangerous position for a business to be. A persistent insolvency can prompt the creditors, who are mainly the people to whom the business has financial obligations, to go to court and have the business declared bankrupt; unable to meet its debts. This effectively means that the business has to be sold and the proceeds used to settle its debts. What remains is what is given to the owner. This marks the end of the business life.
So how can we avoid bankruptcy and insolvency in a business? There are several ways in which we can do this:
Prompt Payment of Debts
It is very important that a business undertakes to settle its debts as they fall due. Accumulating debts can be disastrous for a business. It is even better if a business has more debtors than creditors. It is also in best interest of the business to have a guiding policy about incurring credit. It should have some limit of debts which it should have at any given point in time. It is also important that a business aligns its expected cash flows with a major purchase such as that one of capital goods so that it does not have to buy them on credit.
Proper Management of Resources
It is possible that a business can incur its bankruptcy from mismanagement of resources used in production. This mismanagement leads to losses and therefore the business having more liabilities than the assets. Proper management of resources leads to improved efficiency in production and therefore enhanced profit. This boosts the assets side.
Application of Some Accounting Principles
Application of some accounting principles such as conservatism can help organizations avoid business bankruptcy. This is because it dictates that a loss should be recorded when it is incurred while revenue is recorded when it is actually earned. In other words loss can be speculated while revenue cannot. This keeps business ahead of its debts. Business bankruptcy should be avoided.