Question

Under what set of circumstances might a company have substantial owners' equity and yet not be able to pay its trade vendors in a timely manner?

Answer 1

The ability of a company to pay off its trade vendors primarily depends on the liquidity position of the company. Thus, if the liquidity position of the company is not good then even with substantial amount of owners’ equity the company will struggle to pay its trade vendors. Generally a company should have positive working capital, i.e. the amount of current assets shall be in excess of current liabilities to ensure payment of current liabilities including trade vendors in a timely manner. Thus, if a company struggles to maintain proper working capital due to its inability to collect its receivables on time then even if the company has substantial amount of owners’ equity it will struggle to pay it trade vendors on time.

Hence, under following circumstances a company despite having significant amount of owners’ equity will struggle to pay its trade vendors;

1. The working capital condition of the company is negative, i.e. current liabilities are in excess of current assets.
2. The company does not have an effective strategy to collect its receivables on time.
3. The company has an unfavourable trade policy to pay its creditors.
4. The liquidity position of the company is not good.