Every business starts with a dream, but economic conditions, poor financial metrics and other factors can create a nightmare scenario for business owners: bankruptcy. Business bankruptcies increased 30% in 2023 in the United States, making this an increasingly common situation for business owners to find themselves in. Learning how to manage your cash flow can help you avoid bankruptcy.
What Constitutes a Bankruptcy Situation?
Filing for bankruptcy is not a decision to take lightly, especially in business. Knowing what constitutes a bankruptcy situation is crucial, as you want to exhaust every other option first before going this route.
Your business may be in a bankruptcy situation if the company is failing, and your personal assets are now at risk. For sole proprietors, this is the most common reason to file for bankruptcy.
Bankruptcy can help protect your personal assets if your business goes under.
Large public corporations may also file for bankruptcy if they find themselves unable to pay their debts.
Types of Business Bankruptcy and Their Implications
There are three main types of business bankruptcy:
- Chapter 7
- Chapter 11
- Chapter 13
Each type has its own implications for businesses.
If your business has no viable future, Chapter 7 (liquidation) may be the best option. Businesses file for Chapter 7 when their debts are so overwhelming that restructuring isn’t feasible. Corporations, sole proprietorships and partnerships can all file for Chapter 7.
With this type of bankruptcy, the court takes possession of the business’s assets and distributes them among creditors. Once all assets have been distributed, the owner of the business is released from any obligation for the debts.
If there is a realistic chance that the business can turn things around, then Chapter 11 (reorganization) may be a viable option. Chapter 11 is commonly used by partnerships and corporations, but sole proprietors can also file for this type of bankruptcy if their income levels are too high to qualify for Chapter 13.
With this type of bankruptcy, the business undergoes a restructuring and continues to operate under a court-appointed trustee. Chapter 11 is an exceptionally complex type of bankruptcy, and it doesn’t always succeed. It can take a year or more to develop and confirm a plan.
If you operate as a sole proprietor, you can file for Chapter 13 bankruptcy. Chapter 13 is a reorganization bankruptcy that’s generally reserved for individuals. Because there is no distinction between a sole proprietor and an individual, Chapter 13 is an option.
This type of bankruptcy may be favorable if reorganization and not liquidation are the goals. You will create a repayment plan outlining how you will repay your debts.
The Connection Between Cash Flow Management and Bankruptcy
Financial metrics and cash flow management are fun when your cash is growing, but when you enter into a slow business period, they can be challenging. Proper cash flow management during these difficult times can help you avoid bankruptcy.
If you manage cash flow properly, you can:
- Avoid taking on debt
- Pay bills
- Eliminate late fees
- Avoid high interest rates
Once your cash flow is too low, the risk of bankruptcy is higher because it takes just one loan rejection for you to fall behind on payroll and bills and end up closer to bankruptcy.
Strategies for Effective Cash Flow Management to Avoid Bankruptcy
If you want to avoid bankruptcy, it’s best to use technology to monitor your cash flow. A tool like Cash Flow Frog will make it easier to:
- Analyze current cash flow
- Identify low cash flow issues
If you want to avoid bankruptcy, consider the following cash flow strategies:
- Run cash flow projections
- Monitor your expenses
- Automate sending invoices to be paid earlier
- Reduce expenditures
Accounts receivable factoring can provide short-term liquidity, but you can also secure financing options or consolidate debt to save money.
Role of Financial Professionals in Cash Flow Management and Bankruptcy Prevention
Bankruptcy is very serious for small- and medium-sized companies because it can mean the end of your company. Statistically, hundreds of thousands of companies close due to bankruptcy, but if you do file Chapter 13, you can enter a repayment plan and avoid closure.
Financial professionals can help you:
- Understand your business’s finances
- Unlock cash flow opportunities
- Reduce debt
- Eliminate redundant expenses
If you’re facing potential bankruptcy, financial professionals may be able to find strategic measures to avoid this. For example, you may be able to sell off a low-value division of the company and avoid full closure.
Financial professionals will help you find ways to avoid bankruptcy. If you do need to file bankruptcy, they may be able to guide you through it.
Avoid bankruptcy. Period. You need to do everything in your power to not go into bankruptcy as a business. If you do have to claim bankruptcy, work with an accountant to understand if Chapter 7 or Chapter 13 is the better option for you.
The team at the B2B marketing agency Netrocket helped verify the data in this article.