Bankruptcy, by definition, is the situation where an entity (individual or corporation) is unable to repay his/her debts when and as they fall due. As a result the main drivers of bankruptcy are debt and cash flow.
A company must control both of these levers to analyse historical events and predict future requirements.
Cashflow analysis is widely used throughout the world for this process. Such analysis allows companies to appropriately allocate cash between paying operating expenses, purchasing raw materials, replacing plant and equipment, funding growth and, finally, paying debts.
Many companies, however, fall into the trap of concentrating on profitability rather than cashflows. Whilst there is often a strong correlation between these two concepts, there can be significant differences due to timing of cash inflows and outflows and also due to accrual accounting practices.
As such, it is important for companies to conduct thorough budgeting processes (using both cash and profit forecasts) to understand possible shortages of cash and when their debts are due. To further aid this process, ratio and financial analysis techniques should be used to present an even more accurate picture of current actual conditions, un-cover and possible problems and predict future development trends.
