Liquidity and solvency of healthy and bankrupt entities: Do financial statements show any differences?

Ana Obradović,Maja Obradović,Vule Mizdraković

doi:10.5937/intrev2003123o

Abstract

The aim of this paper is reflected in the analysis of the connection between the financial operations presented in companies' financial statements and the fact whether bankruptcy proceedings have been initiated against the observed companies. Namely, the fundamental indicators of a company's business success, including liquidity and solvency, are of immense significance for all stakeholders, and can also be used to predict the probability whether bankruptcy proceedings will be opened. Bankruptcy authorities make the decision to initiate bankruptcy proceedings, not solely on the basis of the results presented in the financial statements, but predominantly on the basis of the reasons defined by law. However, the question arises whether the fact that bankruptcy proceedings have been initiated correlates with the financial situation as shown in the financial statements. The paper's research sample is made up of the financial reports of two groups of companies, the first group of which includes all the companies in the Republic of Serbia that initiated bankruptcy proceedings in 2019, while the second group consists of randomly selected "healthy" companies. By applying two variables, i.e., liquidity and solvency, we are witnessing a difference in the results of the healthy versus the bankrupt companies. Healthy companies are largely liquid and solvent (47%), but it can be noticed that a number of healthy companies have problems with liquidity. Bankrupt companies are faced with a high liquidity risk, while a small number of them face the problem of insolvency.

Highlights

The analysis of healthy and bankrupt companies’ operating activitiesusing financial reports has long been the authors’prime focus
The legal reasons for initiating bankruptcy proceedings are of tremendous importance, because the bankruptcy judge, based on them, considers whether they are fulfilled on a specific legal entity and decides to initiate bankruptcy proceedings
Some of the most common reasons for initiating bankruptcy proceedings defined in the legal regulations around the globe include: difficulty to settle liabilities as they become due, the assessment of balance sheet solvency and the issue of legal entity’s capital adequacy [5]

Summary

Introduction

The analysis of healthy and bankrupt companies’ operating activitiesusing financial reports has long been the authors’prime focus. The initiation of bankruptcy proceedings in a legal entity will depend primarily on the legal regulations of the state in which it performs economic activity. If we observe and analyze the company’s operating activitiesbased on published financial statements, which should demonstrate a realistic picture of its performance, we can see that some companies meet the reasons for initiating bankruptcy proceedings from the legal point of view, while performing their activities unhindered. We can have a reverse situation, i.e., that the observed legal entity goes into bankruptcy, and that the financial statements show that its operating activities are not endangered. There are various explanations as to why such situations are possible, including: misleading and falsified financial statements, strategic bankruptcy, inadequate legal regulations, inefficiency of judicial bodies, the policy of “sparing” strategically important companies and others. The operating activities of the company as observed through its published financial statements should indicate the fact that the company is undergoing bankruptcy proceedings, despite the previously listed exceptions

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