Question

Why is it possible for a company to show a profit on their income statements and still go bankrupt? If you were looking at the financial statements of a company, how would you go about satisfying yourself that a company was not having cash flow problems? Can you relate any examples of a business going bankrupt, or having to close because of cash flow problems, that you are familiar with; and in your opinion, what was the real cause they ran out of cash.

Answer 1

It is possible that a company show a profit on their income statement and can still go bankrupt.

Assume a company has recorded bad debt in its income statement and shown a profit. While preparing cash flow statement, it has not accounted for that bad debts, thus the cash flow will show higher or positive cash flow, but the company is actually not able to collect that cash and can go bankrupt.

Another example is sometime company sell the product and record the sales, and thus higher profitability, but when company actually collect the cash, it collect less amount, Even the profitability is higher, cash collection is lower and it can result in bankrupcy.