Question

List and discuss two reasons why a business which is making profits can have  difficulties in meeting its debts

Answer 1

Reason 1 -

Financial statement of the company's are prepared based on accrual basis hence what company actually receives on the basis of cash that is more important to repay its obligation. Some times company has huge transaction in the business and for some reason comany could not recovered cash from the accounts receivable or they may have less cash sales as compare to the revenue generated. So due to less money recovered from the debtors and high sales transactions show that as per income statement company has generated huge profit but in reality they did not receive cash.

Due to above reason company can have difficulties in meeting its debts.

Reason 2 -

Businesses borrowed money to expand its business activities and hence they used majority of the fund to invest in the fixed assets and investments.

If company makes investment near the end of the financial year they will not have enough fund to make payment to the borrowed fund.

Some time company use the amount collected in the form of sales and accounts receivable used to pay accounts receivables generated from purchases. To maintain the reputation in the market.

Due to above reasons company can have difficulties in meeting its debts.