When we hear the term "bankruptcy" we immediately think of a dire, all is lost sort of situation. At least that's the first thing that normally comes to my mind. Bankruptcy is a federal legal process designed to give individuals and companies a "fresh start" from unmanageable debt. (Haynes, 2018). It can also be a way for companies to wind up their business process and liquidate assets in an organized manner. On an individual level this prevents creditors from collecting debt from persons who have declared themselves bankrupt. There are several types of bankruptcy but the most common one is Chapter 7 Liquidation Bankruptcy. Bankruptcy is often seen in a negative light, but it is actually a tool to regain financial stability.
Finding and hiring the services of a bankruptcy attorney will take away some of the personal stress that you might encounter but the process is reasonably straightforward.
The Bankruptcy Process
1.Conduct a Bankruptcy counseling session where two mandatory credit counseling sessions must be completed with a counseling agency that has been approved by the U.S. Justice Department.
2.File for Bankruptcy with the court which solidifies your decision to apply for bankruptcy. The bankruptcy appears on the individual’s credit report and this informs creditors to stop calling or making attempts to collect money owed to them.
3. Liquidation or Repayment of mismanaged debt simply means that the individual or company will have to sell or liquidate any assets to repay creditors or in the case of repayment, they would have to pay back over a 3-5 year period
4. Complete a Debtor Education Course which must be completed before having any debts discharged. It is advised that Form 423 Certification About a Financial Management Course, be filed with the court.
5.Debt Discharge is the process by which the debt has been completely cleared and the obligation to pay creditors no longer exists.
6.Naturally, the next step is to begin to re-build your credit.
The Effect of Bankruptcy on Capital Structure
Capital Structure considers how a company finances its assets, whether through debt or equity or other means. Investors are particularly keen about making investments where the return on the capital is greater than the cost of capital. When a company’s capital structure has a high amount of debt it increases interest payments and therefore it raises the risk of bankruptcy. According to Modigliani and Miller theory of capital structure, as a company decides to take on more debt, its weighted average cost of capital (WACC) increases. (Tarver, n.d). This means that the more debt a company takes on the more it must supplement that debt with higher interest payments and this decreases cash-flow and company earnings. By extension this expedites the process of bankruptcy.
Finally, bankruptcy is a legal and useful tool for debtors who have become insolvent and therefore cannot repay their creditors. Therefore, when financing a company’s capital, one must consider the possibility of bankruptcy.
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