How to Avoid Bankruptcy With Smart Financial Management

Bankruptcy is a complex issue with positive and negative consequences. While it can help you or your company wipe out unsecured debts and start fresh, it also leaves a sizeable damage on your personal and business’ creditworthiness.

One of its many bad outcomes is limiting your capacity to obtain credit for a long time. It considerably lowers down your credit score and slims your chances of getting approved for a loan. If you manage to obtain financing, the interest rate will be higher and the terms are less favourable than standard than the standard offer.

Because of its damaging effects, filing for bankruptcy should be considered as a last resort. Carefully going through all available alternatives first before making a potentially life-changing decision is wise.

Understanding Bankruptcy and Its Consequences

Bankruptcy is a legal process that helps individuals and businesses manage or eliminate debts that can no longer be paid. Either these debts have grown to an alarming level that you can no longer manage or you have undergone changes in your lifestyle or business operations that hamper you from repaying your debts on their agreed terms.

There are several types of bankruptcies. However, individuals and businesses usually fall in one of the three following chapters of the Bankruptcy Code:

• Chapter 7 is filed by individuals or businesses with few or no assets. It eliminates unsecured debts, like credit cards and medical bills. Those who have nonexempt assets, like family heirlooms or bonds, are required to sell these assets to repay some or all of their unsecured debts. Those without assets, meanwhile, are free to go.
• Chapter 11. Intended specifically for businesses, it aims to help companies reorganize and become profitable again to repay their debts. Businesses can continue their operations under the court’s supervision while working on a debt repayment plan.
• Chapter 13. This is for individuals and businesses with consistent income and cannot qualify for Chapter 7. It requires individuals and businesses to create workable debt repayment plans, usually in instalments of three to five years. The debtors do not need to surrender or sell their properties.

Regardless of the bankruptcy type you file, the negative impact on your credit score is relatively the same. Generally, it decreases your credit score by 130 to 200 points. This drop is significant, especially if you have a good or fair credit score.

Apart from causing your credit score to plummet, a bankruptcy record also stays on your credit report for many years. Chapters 7 and 11 can stay on your credit report for up to 10 years while Chapter 13 lasts for seven years from the date of filing.

Efficient Financial Management

Because of the long-term damage of bankruptcy on your capacity to obtain financing for future investments or emergency expenses, it is best to be avoided at all costs. The best way to do this is to manage your finances efficiently, regardless if it’s personal or business.

Successful financial management typically requires:

1. Identification of short-term and long-term financial goals
2. Development of a tailored yet realistic financial plan
3. Creation of a budget plan and sticking to it
4. Wealth-building through saving and investing
5. The establishment of good credit

1. Set your financial goals

Financial goals are your savings and spending objectives. They can be short-term, like buying a pair of shoes and travelling abroad, or long-term, like buying a house or saving for retirement. These goals serve as guides to keep your focus and to motivate you to go after your desired results, especially when challenges arise.

To set your financial goals, start by identifying what you want to achieve. This will make it easier for you to develop strategies to reach your objectives. It is also wiser to make your financial goals realistic, especially if you’re new to the whole goal-setting process. This will keep you from getting overwhelmed and eventually abandoning your goals.

While it is okay to dream big, realistic goals are easier to attain in terms of time and resources. Aiming to save 50% of your monthly income is doable, but it could be difficult if you have plenty of bills and debts to pay. Starting small, like saving at least 10% to 20% of your monthly income may be more effective in the long-term.

2. Develop a financial plan

A financial plan is a detailed statement of your financial goals and the strategies you need to take to achieve them. It also identifies the elements of your financial life, such as your income and cash flow, debts, savings, investments, and insurance. By laying out your financial situation, you can easily map out strategies to achieve your goals. You can also identify which goals to prioritise and which ones ones to leave for later.

You can make a financial plan yourself or seek the help of a financial planner. Should you decide to do your plan, ensure that it includes your:

• Goals
• Expenses (where your money goes)
• Retirement Plan
• Emergency Fund
• Debt Repayment
• Investments
• Insurance

A financial plan is also an essential element of a good business plan. It determines whether or not your business idea is viable. Hence, it is one of the most important sections that lenders and investors check when you seek business funding.

Typically, a financial plan for business contains the:

• Income Statement,
• Cash Flow Projection
• Balance Sheet

A brief explanation and analysis of these three factors are also included.

3. Adopt a strategic budgeting approach

Your financial plan is useless without effective budgeting, which is the process of assigning a set amount of money to your different expenses for a given period. To do this, it uses a guide called a budget plan, which outlines the total amount (budget) you have for your expenses and the allocation of this amount into different spending categories. The ultimate is not only to organise spending but to spare a part of the budget for savings and investment.

The typical budget plan covers a one-month or 15-day cycle to match the arrival of income from your employment or business ventures.

There are also different types of budgeting methods to follow. The most common are:

1. 50/30/20. Allocating 50% of your income to essentials, 30% to “wants”, and 20% to savings
2. Envelope. Dividing your income and putting them into several envelopes, which represent different spending categories. Your spending stops when the money in one envelope runs out
3. Zero-based. Your income is allocated to different spending categories. Any unused money in one category will be rolled over to a different category.
4. Value-based. Allocating your money to spending categories that you value
5. “Pay yourself first”. Keeping aside a specific amount to your savings goals while using the remaining money however you choose.

4. Build your wealth by saving and investing

Saving means setting aside a portion of your income for future purchases and emergency expenses. It ensures that you have available funds whenever you need it. Saved money is typically is kept in the bank with a low risk of losing value. While its interest grows over time, this interest is not significant.

Investing is putting your money into an asset intended that produces income or capital gains. It helps grow your wealth with compound interest.

While saving ensures that you have money for a rainy day, it is not enough to secure your financial future. The cost of living is continuously growing that your savings may not be enough to keep up with inflation and support your long-term financial goals like retirement.

The easiest way to secure your financial future is to grow your money. You can effectively do this through investing in various assets, like mutual funds, bonds, commodities and stocks.

5. Establish a good credit

You’ll never when you need to secure personal and business financing in the future.

Using a credit card and taking out loans are essential to establish a credit history and credit score, which are important requirements when borrowing money for personal or business use. Your borrowing power, or creditworthiness, will influence the amount you can borrow for future projects, as well as the interest rate and the terms of the loan.

Your credit scores increase with responsible debt management. Always pay your bills and make your repayments on time and avoid maxing out your credit cards. Ideally, your credit card should not be used beyond 30% of its credit limit.

Debt Consolidation Vs Chapter 13 Bankruptcy

If you want to resolve multiple debt issues but have a regular income and several properties, you can either file for a Chapter 13 Bankruptcy or take out a debt consolidation loan.

As mentioned above, Chapter 13 allows you to repay your debts in 3 to 5 years without being harassed by creditors. However, your credit record will suffer along with your future borrowing prospects.

To avoid this issue, you can get a debt consolidation loan as an alternative. This type of personal financing allows you to borrow money to pay off several older debts.

This process takes out the burden of overwhelming debts to manage. You can also save money on interest and finance charges. Just make sure that your new loan is structured favourably for you so you won’t end up paying more instead.

For your personal and business loan needs, reach out to us at Positive Lending Solutions. We help Aussies across the country get financing to resolve various financial problems. Talk to our loan experts at 1300 722 210 or fill out a Loan Pre-Approval form.

See also:

How to Manage Your Car Loan Effectively

8 Steps to Easy Budgeting

Business Funding: Should You Get a Loan or Borrow from Family and Friends?