Causes of Business Insolvency


Business insolvency is defined as a state or a condition of a company wherein it has an insufficient financial resources to pay off its dues on time. Business can face insolvency because of various reasons. Some of these reasons are internal to business whereas some are external factors. Internal factors are within a control of a business while external factors are out of the scope of its control.

The two important internal causes of business failure are:

a. Lack of start-up capital and working capital

b. Poor capital management

a. Lack of start-up capital and working capital

Most of small and mid-sized companies find it difficult to continue business after few years of establishment. The primary reason for this is the lack of financial resources. Initial or start-up capital proves to be insufficient for such company to provide it with the required working capital.

Working capital is the ready cash that every business requires to carry out day-today business. It is actually a net of business incomes and expenses. Cash flow defines the availability of working capital. If the cash in-flow is more than cash-outflow, the company is said to be in healthy financial situation. However, this is the problem with small-mid sized companies.

For small companies, cash outflow, i.e. its expenses are always more than its inflows, i.e. its income. Expenses are usually regular in nature, whereas income is alike. This creates a negative gap in the cash flow of a company. If not handled properly, the increasing negative gap between income and expenses can lead to more serious financial troubles in a company and in its worst case, can drag a company into a state of business insolvency.

b. Poor capital management

Poor capital management usually affects most of established companies. Many businesses fail because of lack of financial control. The finance managers, who fail to understand the accounting procedures and practices related to cash flow, can lead their company into a big financial trouble. Proper capital management plays important role here.

In mid and big-sized companies, the numbers of transactions that take place are numerous. Recording all transactions properly and accurately is very important.

Proper capital/   finance   management  involves keeping proper tab on cash collection and payments, deposits, the amount of cash deposited and withdrawn, keeping proper record of petty cash, tracking accounts receivables and ensuring timely payments are received from them. You should always keep a check on your finances and should have alerts for low balance watermarks.

Though, the insolvency affects all business, the smaller companies stand at higher risk of failing into insolvency. This is because, they lack financial backup. They find it even harder to generate funds from credit market due to the lack of creditability amongst the financial institutions. Best method to avoid insolvency is to keep a check on your company’s cash-flow.

These two are the most important reasons that can lead a business to insolvency. However, there are certain external factors causing business insolvency as well. Businesses can’t control these external factors. However, it has to have a control over these internal factors that can cause serious damage to a company.

Source by Natalie Fair

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