Introduction
In any business there comes times
when its existence is threatened. The risk of economic fluctuations matter
mostly in the businesses during these times. The most important part of
maintaining a business is preventing and overcoming these risks in the economic
state.
Bankruptcy is often faced in a company
usually because of the poor management decisions and financial crises. The influence
of internal and external risks quite often ends with a profound crisis of the
enterprise, its bankruptcy and liquidation.
The research article taken into
account is about having a deeper insight about the failure of a company in
Lithuania. It gives more understanding of the relationship between the
characteristics of a company, the underlying causes of failure and the
financial effects. (Burksaitiene & Mazintiene, 2011)
Identifying business bankruptcy
Paul Ormerod (2005) reminds us: “Failure
is the most fundamental feature of both biological systems and human social and
economic organizations.” Failure of company relates to a misalignment between
the company and their deployment In order to reach their company’s goal (Turner, 2005) .
- When the company is shortage on resources then they cannot align with the environmental requirements and cannot sustain a strategic position in the market.
- According to the research article Dun & Bradstreet statistics (Holland, 1998) 88, 7 % of all business failures are due to management mistakes. Therefore lack of managerial incompetency leads to lack of motivation and commitment to the company.
- Shortage of finance is the most primary challenges for a failure of a business. Being unable to repay the loans and debts often leads to bankruptcy.
Preventing business bankruptcy
In order to achieve the company
goals and prevent business bankruptcy it is necessary to:
- Analyze existing approaches to finding ways of financial recovery.
- Explore the causes of the crisis and the main directions of their diagnosis.
- Review the effectiveness of the practical applications of the proposed instruments to identify the factors most influence on the activity of the business.
Research methodology and data analysis
The findings in the article were
based on a scientific literature overview and statistical research. The
methodology applied is fundamentally based on grounded theory interpretation
with a focus on classifying the identified relevant variables.
Table 1: Common Sense Failure Detector
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The company signs
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•The company announces using a new accounting company or having new
banking relations;
• Surface of management dispute;
• Resignations of members of the board;
• Reduction of credit line;
• Common stock is sold in a depressed market or for the lower than book
value;
• Company executives sell stocks;
• A major write-off assets take place;
• The company is seen disregarding it‘s decline in financial situation.
|
|
The product signs
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• New competition enters the market;
• Competitors seems to be selling products that are generation ahead; •
Research and development budget is proportionally lower than competitors;
• Retailers always seem to be overstocked;
• Friends and neighbors ask you to explain why you bought that
company’s product
|
Source: Harlan D. Plat., 1999.
The common sense technique uses the
subjective measure therefore even if all thirteen signs are visible the company
may survive or even prosper. Even though these signals do not mean bankruptcy,
they should be treated seriously.
Table 2: Selected financial ratios detecting failure symptoms
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1
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External financing index ratio = Cash from operations/Total external
Financing sources (debt)
|
This ratio shows a company's ability to provide sufficient cash from
its operations to meet its obligations to external creditors when they
mature. This ratio is important to view the liquidity of a company from an
external conservative point of view.
|
|
2
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Cash sources component percentages ratio = Cash from financing/Total
sources of cash
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This ratio relates the cash from financing activities to total cash
sources during the period. This ratio also indicates how much the company
relies on debt and investment by owners rather than cash generated internally
from operating activities or from investing activities.
|
|
3
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Financing policies ratio = Cash from financing activities/Total Assets
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This ratio shows the percentage of assets that were funded by creditors
and owners during the period. A high ratio may indicate that the company is
not using its resources (assets) effectively or to best advantage. A high
ratio also may indicate that the company faces a problem due to additional
cash burden in the future as the interests and loans repayments become due.
|
|
4
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Operating cash index ratio = Cash from operations/Net income
|
This ratio assists current or potential investors and creditors in
evaluating the "quality" of a company's earnings. Generally, the
higher this ratio, the better the quality of earnings. This ratio also
indicates a company's ability to produce cash internally from its ongoing
operations.
|
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5
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Operating cash inflow ratio = Cash from operations/Total sources of
cash
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This ratio indicates what proportion of cash inflows is generated
internally from operating activities. A high ratio generally indicates a
strong financial position for the company.
|
|
6
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Operating cash outflow ratio = Cash used in operations/Total sources of
cash
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This ratio indicates what proportion of total cash generated from all
sources is used in operations. The lower the ratio, the higher the
profitability and the greater the probability of success of the company.
|
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7
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Long-term debt payment ratio = Cash applied to long-term debt/Cash
supplied by long-term debt
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This ratio compares a company's cash disbursements to pay long-term liabilities
with cash receipts from long-term liabilities. Generally, the higher the
ratio, the stronger the company's ability to settle its long-term liabilities
as they become due.
|
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8
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Productivity of assets ratio = Cash from operations/Total assets
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This ratio shows the percentage of cash generated from operating
activities on each dollar of asset invested and measures the productivity of
assets. The higher the ratio, the greater the efficiency of the use of assets
and the better the company's financial position.
|
Source: Using cash flow ratios to
predict business failures. Journal of Managerial Issues, 1995.
The financial ratios are easy to
calculate using company‘s financial statements. The researchers used procedures
for selecting the eight financial ratios from the cash flow statement as they
are most useful in discriminating between bankrupt and non-bankrupt companies.
Conclusion
Bankruptcy management practice in
Lithuania shows that for many of companies hit by the bankruptcy process is
very painful and the initial diagnosis of the signs of the bankruptcy process
is extremely important. The main cause of bankruptcy is a crisis in the company.
Conducting crisis management policies will enable the company to respond
quickly to negative effects of internal and external environment. From a
scientific point of view, this model is a first step towards a consensus on how
and why companies fail which offers a solid theoretical basis for a future
research about failure prevention.
References
Burksaitiene, D., & Mazintiene, A. (2011). THE
ROLE OF BANKRUPTCY FORECASTING IN THE COMPANY MANAGEMENT . ECONOMICS AND
MANAGEMENT, 137- 142.
Turner, I. (2005). Corporate failure . Henely
Manager Update, 1-10.
