Top 5 Reasons Why Companies Go Bankrupt

In the ever-fluctuating landscape of global commerce, the fate of companies ebbs and flows with the currents of market forces. While some businesses thrive and flourish, others find themselves navigating treacherous waters, struggling to stay afloat amidst financial turmoil. Bankruptcy, once considered a rare occurrence, has become an increasingly common phenomenon in today’s volatile economic environment.

The spectre of bankruptcy casts a shadow over businesses and industries, from small startups to multinational corporations. Behind every bankruptcy declaration lies a complex web of factors—economic downturns, mismanagement, disruptive technological advancements, or even unforeseen global crises. Yet, beyond the headlines and financial figures, there is a narrative rich with lessons and insights into the inner workings of corporate structures and the broader economy.

In this article, we will delve into the multifaceted realm of corporate downfall, seeking to unravel the top five reasons why companies go bankrupt. We will also shed light on the mechanisms and warning signs that precede financial distress and unveil the aftermath of bankruptcy. By doing so, we hope to provide you, readers, with a deeper understanding of the precarious balance between success and collapse in the corporate world.

Once Upon a Kodak

“Kodak didn’t just set the tone for the film and camera industry; it was the film and camera industry.”

On a cold January morning back in 2012, the world woke up to some distressing news despite having the sequence of events inevitably going in that very direction. Kodak, once a giant in the camera industry, filed for Chapter 11 bankruptcy—this is a legal process that enables businesses to restructure their debts while continuing to operate. 

Although Kodak recovered from bankruptcy in September 2013, having shed much of its debt and legacy obligations, it emerged back as a much smaller company compared to its heyday, with a reduced presence in the consumer photography market.

So, how could a giant company such as Kodak, after literally revolutionising, developing, and dominating the entire camera and film industry for the most part of the past century, go under?

Long story short, the main reason why Kodak went bankrupt is basically its failure to adapt to the digital revolution in photography. Despite being a pioneer in film photography, the company struggled to keep pace with the rapid shift from film to digital photography, which drastically changed consumer preferences and industry dynamics.

Kodak failed to innovate and capitalise on digital imaging technologies, leading to declining sales of its traditional film products and loss of market share to competitors. Add to this the high debt levels and legacy costs that further strained Kodak’s financial health, ultimately resulting in its bankruptcy filing.

Reasons Why Companies Go Bankrupt

Corporate bankruptcy, also known as business bankruptcy, is a legal process through which a company that is unable to meet its financial obligations seeks relief from its debts. In other words, it is a formal declaration that the company is unable to pay its creditors or fulfil its debts as they become due.

This declaration is then followed by a series of legal proceedings overseen by a court aimed at resolving the company’s financial distress while balancing the interests of various stakeholders. Credits most probably recover only a portion of what they are owed, employees may face job losses or changes in employment terms, shareholders can see a decline in the value of their investments, and economic disruptions do happen due to supply chain interruptions. 

Do you know what else corporate bankruptcy leads to? Decreased consumer confidence and reputational damage, which together may hamper the company’s ability to regain market share, while legal proceedings and associated costs can further strain resources. The loss of intellectual property and assets can also diminish long-term competitiveness.

This is a tiny glimpse of what bankruptcy can do to businesses; pretty unpleasant and must be avoided at all costs. To do that, companies and business owners should be aware of the implications that eventually lead to their downfall. So, let’s explore the top five reasons why companies go under.

1. Poor Financial Management

The first reason that often leads to bankruptcy is poor financial management for it creates a cascade of challenges that undermine a company’s financial stability and operational viability.

When financial resources are misallocated or mismanaged, companies may find themselves facing cash flow problems and unable to cover essential expenses such as payroll, rent, or debt payments. Inadequate cash flow management can exacerbate liquidity issues, leading to a downward spiral where the company struggles to meet its financial obligations and creditors become increasingly impatient.

Without sufficient liquidity to sustain operations, companies may be forced to seek external financing at unfavourable terms or resort to asset liquidation to generate cash, further depleting their resources and eroding their ability to recover.

It does not stop there, however. Poor financial management can manifest in excessive debt levels, inefficient cost control, and a lack of strategic planning, which in turn exacerbates financial vulnerabilities and increases the risk of insolvency. Companies burdened with high levels of debt may struggle to service interest payments or refinance debt obligations. The result? Credit rating deterioration and the dimension of access to capital markets.

Do you know what else accelerates the ride to bankruptcy? Inefficient cost management practices. These include overspending on non-essential expenses or neglecting to optimise production processes, the two of which can erode profitability and margins and further strain financial resources, not to mention the lack of strategic planning and foresight, which often leave companies ill-prepared to navigate changing market dynamics, increasing their susceptibility to financial distress and, ultimately, bankruptcy.

2. Economic Downturns

Economic downturns are periods of contraction or decline in economic activity, typically characterised by decreased production, reduced consumer spending, tightening credit markets, rising unemployment, declining business investment, and heightened financial distress across industries.

One of the most famous yet severe examples of economic downturns is the Great Depression (1929–1941). It was sparked by the US stock market crash of 1929 and spread to many other countries, leading to a prolonged period of widespread unemployment, huge bank failures, and a sharp decline in global trade and industrial production, a global economic hardship that was further manifested by the outbreak and progression of World War II.

The most recent global economic downturn was, of course, caused by the COVID-19 pandemic, which took its toll on the entire planet and whose consequences have shaped our present. Governments implementing lockdown measures to contain the spread of the virus caused unprecedented disruptions to global supply chains, widespread business closures, a huge global layoff, and a sharp decline in consumer spending, all of which led to recession.

During economic downturns, consumers often cut back on discretionary spending, resulting in reduced demand for goods and services. Such a decline in consumer demand can adversely affect companies’ revenue streams, particularly those operating in industries sensitive to economic cycles, such as retail, hospitality, and automotive. The decline in sales and shrinkage of profit margins causes companies to struggle to maintain cash flow and meet their financial obligations, increasing the risk of insolvency.

Simultaneously, economic downturns can exacerbate liquidity constraints for companies as credit markets tighten and financing becomes more expensive and difficult to obtain. Banks and all financial institutions may become more cautious in extending credit to businesses, which restricts access to capital for investment, working capital, or debt refinancing.

This mostly impacts companies heavily reliant on external financing to support their operations or fund expansion initiatives. The liquidity shortages make it challenging for them to sustain operations and service existing debt obligations and force them to explore restructuring options, seek bankruptcy protection, or undergo asset liquidation to survive the economic downturn.

All in all, when companies struggle to adapt to changing market conditions caused by economic recessions or downturns, they inevitably encounter financial difficulties and, maybe, bankruptcy.

3. Market Changes

The third most common reason why companies seek refuge in filing for bankruptcy is precisely what put Kodak out of business: failure to adapt to market changes, shifting consumer preferences, technological advancements, or competitive dynamics.

Rapid changes in consumer behaviour, including the adoption of new technologies or shifts in purchasing habits, like the case with online shopping, can disrupt established business models and erode the market share of incumbent companies. Failure to anticipate or respond effectively to these changes can leave companies vulnerable to declining sales, shrinking revenue, and, ultimately, financial distress.

Add to this the emergence of competitors or disruptive innovations which often challenge the market position of already-established companies, intensify competition and erode profitability. In other words, when companies are slow to innovate, differentiate their products or services, or pivot their business strategies in response to various market changes, they may find themselves unable to compete effectively, leading to declining revenues and increased risk of bankruptcy.

Market changes can also accelerate market consolidation as weaker players struggle to survive or are acquired by larger competitors seeking to bolster their market position or access new growth opportunities. Companies that fail to adapt to industry disruptions risk being left behind, unable to compete effectively or differentiate themselves in an increasingly crowded and competitive marketplace, ultimately leading to financial distress and the prospect of bankruptcy.

What is more, changes in regulatory environments, industry standards, or geopolitical factors can increase compliance costs, disrupt supply chains, or limit market access, all of which contribute to financial challenges for companies and affect their profitability and operational efficiency.

Another famous example of a company going bankrupt because of market changes is Toys “R” Us. This company was once a beloved toy retailer and a staple of childhood memories for millions of people. After growing into a global powerhouse with a vast network of stores across the United States and around the world, it went bankrupt in 2017. 

Besides the heavy debt burden that resulted in a leveraged buyout back in 2005, Toys “R” Us struggled to adapt to the rise of online shopping and e-commerce, which led to declining sales and financial difficulties. The company also faced intense competition from online retailers like Amazon, who offered greater convenience, lower prices, and a wider selection of products.

This left Toys “R” Us at a disadvantage in the rapidly evolving retail landscape and contributed to its downfall and eventual bankruptcy.

4. Overexpansion

Pretty counterintuitive, we know. But stay with us here.

Overexpansion or rapid growth can be a double-edged sword for companies, often leading to bankruptcy when not managed effectively. What we know for sure is that expansion fuels increased revenues and market share, yet it also comes with heightened operational complexities, financial risks, and resource constraints. Companies that expand too quickly may overextend their resources, including capital, manpower, and infrastructure, to support growth initiatives without adequate planning or risk assessment.

As a result, companies struggle to meet escalating expenses, debt obligations, and working capital needs, which, in turn, strains liquidity, erodes profitability, and leads to cash flow challenges. Additionally, rapid growth may outpace the company’s ability to scale its operations, resulting in operational inefficiencies, supply chain disruptions, or quality control issues that can compromise product or service delivery and sabotage customer satisfaction.

Aside from that, overexpansion can expose companies to increased market volatility and competitive pressures, particularly in industries characterised by rapid technological advancements or shifting consumer preferences. Excessive leverage or debt incurred to finance expansion initiatives can amplify financial risks, especially if revenue growth fails to materialise as expected.

So, yes. Too much growth is just as problematic as eating too many doughnuts.

5. Management Issues

Do you know who else can highly influence bankruptcy? Bad managers who have near-zero experience in how to manage a company. 

Bad managers often have poor decision-making skills, so when they fail to anticipate or react effectively to changes in market conditions, they infuse financial vulnerabilities and liquidity challenges. Their leadership is ineffective, which leads to a multitude of challenges, including misallocation of resources, operational inefficiencies, and strategic missteps that cut down on profitability and market competitiveness.

Other inadequate management issues that may influence bankruptcy in the long term are conflicts of interest, ethical lapses, or lack of transparency in decision-making. Those undermine trust among stakeholders, including investors, creditors, and employees, leading to reputational damage and decreased confidence in the company’s leadership.

Excessive risk-taking, aggressive expansion strategies, or neglecting to establish adequate internal controls are other facets of serious management issues pretty common with companies foreseen filing for bankruptcy in the near future. You know why? Because these issues bring about flow problems, even more excessive debt levels, and operational disruptions.

Conclusion

The reasons behind a company’s bankruptcy are often multifaceted and interconnected, reflecting a combination of internal challenges and external factors. Poor financial management, economic downturns, market changes, overexpansion, management issues, and external events can all contribute to financial distress and ultimately lead to bankruptcy.

While some factors may be within the company’s control, such as strategic decision-making and operational efficiency, others may be influenced by broader economic, regulatory, or market forces beyond its control. Recognising the warning signs of financial instability, implementing effective risk management strategies, and maintaining agility and adaptability in response to changing market conditions are essential for companies to navigate challenges and safeguard their long-term viability.

By understanding the complex thread of factors that can lead to bankruptcy, companies can better position themselves to weather economic storms and emerge robust and more resilient in the face of adversity.