Accounts Receivable Dictionary

What is Bankrupcy?

Bankruptcy is a legal process where individuals or businesses that cannot repay their debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debtor.

Importance in Accounts Receivable

Bankruptcy is a critical term in accounts receivable (AR) management because it directly affects a company's ability to collect outstanding debts. When a debtor declares bankruptcy, it often means they cannot fulfill their financial obligations, which includes paying invoices. For AR management, understanding bankruptcy is vital to effectively manage risk, evaluate financial health, and make informed decisions on credit terms.

In Practice

In practice, once a debtor declares bankruptcy, they are generally protected from further collection activities, including those from accounts receivable departments. The outstanding debts may be discharged or reorganized depending on the type of bankruptcy filed. AR departments must then write off these debts or work within the bankruptcy court's parameters to recoup what they can.


For instance, a small business might provide services to Company X on credit. However, if Company X files for bankruptcy, the small business would likely be unable to collect the full amount owed, impacting their cash flow and financial health. They would then have to participate in the bankruptcy proceedings to potentially recover a portion of the debt.

Related Terms

  1. Write-offs: The reduction of the value of an asset, in this case, the value of total accounts receivable, due to uncollectible debt.
  2. Debt Discharge: The cancellation of a debt due to bankruptcy proceedings.
  3. Bankruptcy Protection: Legal status offering the debtor protection from certain obligations and actions from creditors.


What happens to accounts receivable when a debtor declares bankruptcy?

When a debtor declares bankruptcy, the accounts receivable associated with that debtor become highly uncertain. Depending on the type of bankruptcy filed (Chapter 7, 11, or 13 for individuals, Chapter 7 or 11 for businesses), the debtor may be discharged of their debt obligations, or a repayment plan may be created.

Once bankruptcy is declared, an automatic stay is imposed, which prevents creditors, including those with accounts receivable from the debtor, from pursuing collection efforts. If the debtor is undergoing liquidation (Chapter 7), any assets are sold to repay creditors, though unsecured creditors like those with accounts receivable are paid last and often receive pennies on the dollar. If the debtor is reorganizing (Chapter 11 or 13), a plan is devised to pay creditors over time, which might involve reducing the overall debt owed.

How does bankruptcy affect the cash flow of a business?

Bankruptcy of a debtor can significantly impact the cash flow of a business. If accounts receivable from the debtor form a substantial part of the business's incoming cash flow, their bankruptcy could cause a sudden decrease in cash inflows. In the short term, this could cause liquidity problems and difficulty meeting operational costs. Over the long term, it could lead to reduced profitability and even insolvency if the business can't replace the lost revenue.

What are the different types of bankruptcy and how do they affect AR?

The two most common types of bankruptcy that impact accounts receivable are Chapter 7 and Chapter 11.

  • Chapter 7: In Chapter 7 bankruptcy, the debtor's assets are liquidated to pay off their debts. However, secured creditors are paid first, with unsecured creditors like those with accounts receivable often receiving little or nothing. Once the bankruptcy is finalized, the debtor is typically discharged of any remaining unpaid debts.
  • Chapter 11: In Chapter 11 bankruptcy, the debtor usually keeps their assets and works out a plan to repay creditors over time. This could mean that accounts receivable are paid, but possibly not in full or as quickly as the creditor might hope. There's also a risk that the debtor's reorganization fails, potentially leading to a later liquidation under Chapter 7.

In either case, the business with accounts receivable from the debtor will have to write off some or all of that receivable, leading to a direct hit to their income and cash flow.


In conclusion, understanding the concept of bankruptcy is critical for effective accounts receivable management. It provides insight into potential risks associated with credit transactions and influences decision-making processes regarding credit policies. Though it's an undesirable situation, being well-versed in handling bankruptcy cases ensures better financial preparedness and resilience.