How can a Profitable Company can Go Bankrupt?

May 31, 2017

To manage a business is perhaps the riskiest job one can ask for. Essentially during a start-up, it is estimated by certain research that around 49% of businesses fail or go bankrupt within the first five years and 30% businesses don’t even make it up to the one or two-year mark. While some companies might be risky in nature like opening up a restaurant or in recent times a technology related setup which has a higher failure rate. It is not only the nature of the business that leads to failure, but factors such as poor leadership, incorrect direction, poor financial planning in spite of having a great idea, product or service, with the probability of hitting gold in the first few years could also fail.

Depending on the way the business functions, the way it manages its finances, a company could move towards bankruptcy. It is a known fact that an increase in sales is directly proportionate to an increase in revenue. However, most start-ups or established businesses manage to oversee the fact that an increase in sales or business also means that there is an increase in inventory and accounts receivable that use up the cash. A phase in growth could also literally mean to be cash flow negative in the short term.

To maximise profits should be the ultimate goal of a company, but being profitable is only one side of the coin. It is equally important for the company to be profitable and being able to pay the bills when they are due. Many businesses, small or big come across customers who pay their bills for the services or goods in 45-60 days, yet owners or companies have to honour their commitments to the staff and vendors in 30 days, plus overheads, which means irrespective of when they receive payments they have to make arrangements on an ongoing basis.

Cash Flow is the king for business owners, without which businesses can get caught in the situation and in spite of being profitable may end up going out of business.

It is an oxymoron that a business which is profitable and has plenty of sales lined up goes down. If the cash flow is not there, even profitable businesses can go kaput.

Keeping all another variable aside, here are some reasons why certain profitable companies can go under…

Ignoring cash flow and focusing on profit

No cash flow, zero business, not a happy ending! So the priority cannot be on profitability but cash flow. Some big projects can pay well but if the payment cycle is too long a wait it can create cash flow pressures which will come in the way of functioning. Business decisions need to be based on this mindset.

Receivables and payables have a rocky marriage

Receivables is the money owed to you by clients and payables is the money you pay to your suppliers or vendors, overheads etc., In an ideal scenario there should no receivables that are overdue and the company should always have the cash in hand for payables, but like all real life truths this is never the case. As a company, you cannot be lenient in this department and if required should have a separate team that works on this to ensure the cash flow.

Overestimate stock

Remember extra stock is a result of poor planning which is holding your cash flow. Even at times when the business is good, shelving stocks is not the best thing to do. To increase profits again don’t simply buy more stocks on sale. Be acutely aware of what is required as it is pivotal to business.

Incorrect Invoicing

Good finance is the backbone of your business, not knowing who owes you money is criminal pressure on cash flow. Use technology to avoid this mess.

Offering Credit

A company puts itself and the connected people at risk by extending credit and selling to people who cannot pay, such altruistic acts have no place in business.

Cash flow is imperative to sustain and excel. Amazon was not profitable in the first decade but it had great cash flow by selling stocks in the mid-1990’s, almost every year they spent more than they earned. Their first profit was nearly after a decade of being in business, but mind it they could be in business because of cash flow. The stock market ensured cash flow which made up for the losses, which has made them both profitable and a company with cash flow today.

Good Financial Planning + Cash Flow = Great Business (along with disclaimers of course!)

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