Business failure can occur due to economic downturn, mismanagement, unexpected rise in competition, changes in laws and regulations with adverse affect on the operations of the enterprise.
There are various degrees of business failure. Each subsequent is more serious than the previous one.
The least serious type of business failure occurs when business cannot earn a return that is larger than organization’s cost of capital.
Technical insolvency is a more serious type of business failure and occurs when organization is not able to meet its current liabilities as it comes due.However, organization’s assets are still larger than its liabilities. In such situation organization can avoid bankruptcy by converting its fixed assets into cash in a timely manner to cover its current liabilities.
Bankruptcy is even more serious type of business failure. It occurs when organization’s liabilities exceed its assets.
Bankrupt firm can undergo reorganization.