What Is Asset Deficiency?
Asset deficiency is asituation where a company's liabilities exceed its assets. Asset deficiency is a sign of financial distress and indicates that a company may default on its obligations to creditors and may be headed for bankruptcy.
Asset deficiency can also cause a publicly traded company to be delisted from a stock exchange. A company may be involuntarily delistedforfailing to meet minimum financial standards. When a company no longer meets listing requirements, the listing exchange will issuea warning of noncompliance. If the company fails to address and correct the issues outlined in the warning, the company's stock may be delisted.
Key Takeaways
- If a company's liabilities exceed its assets, this is a sign of asset deficiency and an indicator the company may default on its obligations and be headed for bankruptcy.
- Companies experiencing asset deficiency usually exhibit warning signs that show up in their financial statements.
- Red flags that a company's financial health might be in jeopardy include negative cash flows, declining sales, and a high debt load.
- By filing for Chapter 11 bankruptcy, a failing company is allowed to reorganize and restructure as it attempts to regain profitability.
- In a worst-case scenario, asset deficiency may force a company to file for Chapter 7 bankruptcy, which means the company will go out of business entirely, liquidating as a means to pay off its creditors and bondholders.
Understanding Asset Deficiency
While a company may experience a temporary or short-term asset deficiency, there are usually warning signs that indicate the financial distress is much more serious and could lead to the company's failure. Reviewing a company's financial statements over a few years can help investors get a clearer picture of the company's current health and future prospects.
Key points to look for would be negative cash flows in the cash flow statement. Negative cash flow could be a sign that managers are not efficient at using the company's assets to generate revenue. Poor sales growth and declining sales over a period of time could indicate insufficient demand for a company's products or services.
Investors should also review a company's debt load, which can be found on the balance sheet and represents the amount of debt the company is carrying on its books. High fixed costs combined with a high debt load and income insufficient to pay liabilities are all red flags that a company's financial health is in jeopardy.
A simple way for investors to research a publicly traded company's financial statements is to go to the company's investor relations (IR) page on its website to access the company's quarterly and annual reports.
Asset Deficiency and Bankruptcy
A company that has a chance at recovering financially may file for Chapter 11 bankruptcy, under which the company is restructured, continues to operate, and attempts to regain profitability. As part of a Chapter 11 reorganization plan, a companymay choose to downsizeits business operations to reduce expenses, as well as renegotiate itsdebts.
In a worst-case scenario, asset deficiency may force a company to liquidate as a means to pay off its creditors and bondholders. The company wouldfile for Chapter 7 bankruptcy and go completely out of business. In this situation, shareholders are the last to be repaid, and they may not receive any money at all.
If a company succeeds with its restructuringin Chapter 11, it will typicallycontinue operating in an efficient manner under its new debt structure. If it is not successful, then the companywill likelyfile for Chapter 7 andliquidate.
Example of Asset Deficiency
Following the financial crisis of 2007-2008, many U.S. companies struggled to stay afloat, finding themselves with limited assets and growing liabilities. While many succumbed to asset deficiency and folded, others opted for Chapter 11 restructuring and some eventually reemerged from bankruptcy as profitable businesses.
Two of Detroit's Big Three automakers—Chrysler and General Motors—filed for Chapter 11 protection in 2009. Despite closing thousands of dealerships and laying off tens of thousands of employees, neither company could survive the dramatic decline in new car sales brought about by the Great Recession. The U.S. Treasury ended up bailing out both car companies through loans from the Troubled Asset Relief Program (TARP).
By 2012, however, the fortunes of Chrysler and General Motors had turned around significantly. Both companies repaid their bailout loans and enjoyed a rebound back into profitability.
