BUSINESS FAILURE,

REORGANIZATION,
AND LIQUIDATION
Business firms operate in an environment that is
dynamic and changes happen every now and
then…..These changes could be favorable to some
firms and the resulting growth and expansion in
activities are desirable developments. To some
firms, however, environment changes bring
unwanted consequences and one of these is
business failure…
BUSINESS FAILURE REFERS TO THE FOLLOWING
1. All industrial and commercial enterprises that are petitioned for
bankruptcy in the courts.

2. Concern which are forced out of business through such actions in the
courts as foreclose, executions, and attachment with insufficient
assets to cover all claims.

3. Concerns involved in action in courts and other government agencies (

like the securities and exchange commission and the central bank)
such as receivership, reorganization, nor arrangement.

4. Voluntary discontinuance with known loss to creditors and…

5. Voluntary comprises with creditors out of court.

CLASSES OF FAILURES

1. Economic Failure – This happen when firm’s revenues no

longer costs.

2. Financial Failure – This happen when the firm becomes

insolvent or is unable to pay its debts.

Financial failure is a result of any following:

a. When the firm’s assets are more than its liabilities, but with the
assets not liquid enough to settle, its maturing obligation

b. When the firm’s assets are less than its liabilities

 CAUSES OF FAILURE
External Causes of Failure
 1. Recession
 2. Changes in government regulation or contacts
 3. Burdensome taxes or tariffs
 4. Court decisions
 5. Legislation unfavorable to the specific type of business or to
business in general
 6. Strikes or boycotts
 7. Labor costs
 8. Dishonest employees
 9. Disaster or “acts of God”
 Internal Causes of Failure
1. Overcapitalization in debt

2. Undercapitalization in equity

3. Inefficient management of income

4. Inferior merchandise

5. Improper costing with excessive expenditures

6. errors of judgement concerning problems or expansion

7. Inefficient pricing decisions

8. Inability to improve a weak competitive position

 SYMPTOMS OF FAILURE
 Cash Flow to Total Debt – Viable firms have higher cash flow to total debt ratio. When this ratio
gets lower, the financial standing of the firm weakens and when it gets even lower, failure
approaches.
 Market Price – Approaching failure is also indicated by declining market price of the firm’s
stock. This is the result of the decreasing confidence of the investors in the survival of the firm.
 Working Capital to Total Assets – When The ratio declines, failure approaches. The declines
reflects the inadequacy of working capital.
 Retained Earnings to Total Assets – Retained earnings provide a source of funding for
unexpected costs, delays, or credit crunches. A decline in this ratio indicates an approaching
failure.
 Earning Before Interest & Taxes to Total Assets – This ratio reflects the adequacy of cash flow
in relation to the firm’s liabilities. A lower ratio means a lesser chance of settling debts.
 Market Value of Equity to Book Value Of Debt – When Debts are used excessively, the
market value of the stock goes down because of increased financial risk. This is indicate by a
lowering down of he ratio.
 Sales to Total Assets – A decreasing sales to total assets ratio reflects a shrinking market of the
product. As the ratio gets lower, the firm approaches failure.
 REMEDIAL ACTION FOR BUSINESS FAILURES
REHABILITATION – is an attempt to keep the firm going. It may be achieved
through any of the following:
 1. Formal proceeding called reorganization
 2. Voluntary agreement

REORGANIZATION – This term refers to a formal proceeding under the supervision

of a court, including short-term liabilities, long-term debt and stockholders equity, in
order to correct gradually the firm’s immediate inability to meet its current payment.
 Reorganization plans may call for:
 1. Refinancing
 2. Capitalization
REFINANCING – Refers to the replacement of outstanding securities by
the sale of new securities.

Refinancing may be classified as:

1. Refunding
2. Funding
3. Reverse Funding

REFUNDING – Refers to the sale of a new bond issue to replace an

existing bond.

FUNDING – the retirement of a preferred stock with the proceeds of

borrowing.

RECAPITALIZATION – is undertaken when a group of existing security

holders accepts a new issue in voluntary
exchange for the issue it now holds.
VOLUNTARY AGREEMENT - When the creditors and stockholders agree to
give the firm a chance to get back on the right
track under a mutually accepted plan,
Voluntary Agreement may fall under any of the following;
1. extension
2. Composition
3. Creditor Management

LIQUIDATION – Occurs when the firm dissolves and ceases to exits and its
assets are sold.

- May be accomplished trough any of the following:

ASSIGNMENT – is an out of court settlement where the creditors select a

trustee to sell the assets and distribute the proceeds.
BANKRUPTCY – It is legal process by which a person or
business that is unable to meet financial obligation is
relieved of those debts by the court. The court divides
whatever is left of the assets of the person or firm among
creditors, allowing creditors at least part of their money
and freeing the debtor to begin a new.
 REMEDIAL ACTION FOR
BUSINESS FAILURE

REHABILITATION LIQUIDATION

REORGANIZATION VOLUNTARY
AGREEMENT
ASSIGNMENT BANKRUPTCY

RECAPITALIZATION EXTENSION

COMPOSITION

REFINANCING
CREDITOR
MANAGEMENT

REVERSE
REFUNDING FUNDING
FUNDING