You may see the term "profitable bankruptcy" in economic news.

Many people may wonder why a company goes bankrupt even though it is in the black.

This time, we will introduce the basic mechanism of profitable bankruptcy and measures to avoid falling into profitable bankruptcy.

Various states of bankruptcy

Bankruptcy is a state in which an individual or corporation becomes unable to carry out normal economic activity due to insolvency.

"Bankruptcy" is not an official legal term, but it is a commonly used term, such as when laws related to bankruptcy, such as the Bankruptcy Act, Civil Rehabilitation Act, and Corporate Reorganization Act, are collectively referred to as "bankruptcy laws."

Bankruptcy can occur as a result of a legal petition by creditors, a bank ceasing payments (so-called dishonored bills), or the management deciding to undergo private restructuring.

Legal and private reorganization

Bankruptcy procedures include legal reorganization and private reorganization.
Legal bankruptcy is a procedure in which debts are restructured with the involvement of a court based on laws such as the Corporate Reorganization Act, Civil Rehabilitation Act, and Bankruptcy Act.

There are liquidation procedures, in which debts are settled and the business is terminated, and reconstruction procedures, in which the aim is to rebuild the business after political reorganization.
Private reorganization is a procedure in which a business operator negotiates with creditors for payment deferrals or debt forgiveness in order to reorganize its debts.

Reasons why black-ink bankruptcies occur

A company going bankrupt is a separate issue from whether it posts a profit or a loss.

Whether a company is in the black or not is determined by whether the book profit and loss is positive or negative, and it is possible for the book profit and loss to be positive (in the black) even if a company becomes insolvent due to a lack of funds.

Unplanned cash outs or non-receipt of planned funds can result in a funds deficiency even though the figures on the books are positive.

The payment period for sales is shorter than the receipt period

The "payment period" is the period from when a sale is recorded until when the payment is actually received.

In the case of retail stores and restaurants, payment is received shortly after goods or services are provided, so the payment period is short.

The "payment term" is the period between when you purchase something and when you pay for it.

If the payment term is short, you will have to pay for your purchases without receiving any sales revenue, so you will need working capital. However, if you don't have enough working capital, your purchase payments will be delayed and you will go bankrupt.

In this case, the income statement shows a profit because the sales and corresponding purchases have already been recorded.

However, on the balance sheet, sales are recorded as "accounts receivable," and cash is reduced by the amount of purchases. If this situation continues, the company will run out of funds and go bankrupt even though it is in the black.

Especially when business is going well and you need to increase purchases and inventory, it is easy to run into a shortage of working capital, which can lead to bankruptcy even if you are profitable.

We have dead stock

There would be no problem if the inventory were converted into sales as planned and smoothly converted into cash, but due to a deterioration in market conditions, changes in the environment, or shifts in consumer needs and preferences, the purchased inventory may become dead stock.

If you continue to pay for your purchases without being able to turn dead inventory into cash, your cash reserves will decrease and you will eventually go bankrupt even though you are making a profit.

Deteriorating business conditions at business partners

A typical example of a large company going bankrupt despite being profitable is when a business partner's business deteriorates and sales revenue is not received as scheduled, resulting in a cash shortage.

This type of case is difficult to predict in advance, and it is often only discovered just before the scheduled payment date that a business partner's business situation deteriorates and it can easily trigger a company going bankrupt even when it is profitable.

Three measures to avoid going bankrupt even if you are profitable

Since a company going bankrupt even when it is profitable makes its performance appear to be good, it is not rare for even management to not realize the risk of bankruptcy until the last minute.

In order to avoid going bankrupt even when you are profitable, it is important to manage your business with an emphasis on cash flow on a daily basis.

It is also important to prepare fundraising methods such as borrowing and factoring in case you find yourself short of funds due to unforeseen circumstances.

Manage cash flow forecasts and actual results

Preparing a cash flow statement and managing your daily cash flow projections and actuals is the most basic measure to avoid bankruptcy even when profitable.

If possible, prepare a three to six month budget and periodically compare it with actual results. Don't leave it to the financial department, but hold regular meetings with the business owner to check and understand the current financial situation.

Especially when expanding your business, you will increase your purchases and make capital investments, which will result in more cash outflows, so it is important to frequently check whether you have enough working capital.

Negotiate deposit and payment terms

We sometimes come across cases where the payment term for purchases is the current month and payment is due in the current month, and the payment term for incoming payments is the current month and payment is due in the month after next.

If you do not have enough working capital, it is important to improve your cash flow by taking measures such as delaying payment until the following month.

Some projects may take several months to complete.

In such long-term projects, personnel costs and other expenses incurred during the project period are paid out first, which can make cash flow difficult.

In such cases, we recommend that you set up a down payment, interim payment, etc., and put in place a system to recover even some of the funds.

Raise funds through borrowing and factoring

When you find yourself short of funds due to unforeseen circumstances, such as a deterioration in the financial condition of a business partner, you will need to raise funds quickly.

Even if you try to negotiate with a financial institution suddenly, it will often take some time before the loan is granted, so it is important to communicate with financial institutions on a regular basis.

If possible, it may be effective to take measures such as securing a credit limit.

Recently, the number of financial institutions and non-banks offering factoring services has been increasing.

Factoring is a service that allows you to purchase accounts receivable before the due date. The purchase price varies depending on the creditworthiness of the creditor, but the difference between the amount of the receivable and the purchase price is the fee.

It may be too late to resort to factoring once you find yourself in a difficult situation, so it is a good idea to consult with a factoring company while you are still in peacetime.

Prevent the risk of bankruptcy even when profitable through cash flow management

Bankruptcies in the black are not uncommon. According to a survey by Tokyo Shoko Research, the ratio of black-ink bankruptcies to red-ink bankruptcies in 2020 was almost half and half.

The fact that there are so many cases of companies going bankrupt due to a lack of cash on hand despite making a profit from their core business means that many companies are neglecting management that prioritizes cash flow.

While the calculated business income and expenditure is of course important, it is equally important to prepare a cash flow statement and check your daily cash flow.

Taking a long-term perspective and thinking about how to increase cash flow will bring stability to your business.