Financial distress is a term in
corporate finance used to indicate a condition when promises to
creditors of a
company
A company, abbreviated as co., is a Legal personality, legal entity representing an association of legal people, whether Natural person, natural, Juridical person, juridical or a mixture of both, with a specific objective. Company members ...
are
broken or honored with difficulty. If financial distress cannot be relieved, it can lead to
bankruptcy. Financial distress is usually associated with some
cost
Cost is the value of money that has been used up to produce something or deliver a service, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it i ...
s to the company; these are known as ''costs of financial distress''.
Cost
A common example of a cost of financial distress is bankruptcy costs. These
direct costs include
auditors'
fees, legal fees, management fees and other payments. Cost of financial distress can occur even if bankruptcy is avoided (
indirect costs).
Financial distress in companies requires
management
Management (or managing) is the administration of organizations, whether businesses, nonprofit organizations, or a Government agency, government bodies through business administration, Nonprofit studies, nonprofit management, or the political s ...
attention and might lead to reduced attention on the operations of the company.
Another source of indirect costs of financial distress are higher
costs of capital as usually
bank
A bank is a financial institution that accepts Deposit account, deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital m ...
s increase the
interest rates if a state of financial distress occurs.
Options for relieving financial distress
If high
debt burden is the cause of financial distress, the company can undergo a
debt restructuring.
If operational issues are the reason for the distress, the company can negotiate a payment holiday with its
creditors, while improving
operational efficiency so as to be able to service its debt.
If the latter improvements are insufficient, the company may engage in the more extensive
turnaround management.
See for discussion.
External links
Indicators and Sources of Financial Distress''Predicting Financial Distress of Companies: Revisiting the Z-Score and Zeta Models by Edward Altman''''Financial Distress, Bankruptcy Law, and the Business Cycle by Javier Suarez and Oren Sussman''Insolvency Service websiteProbability of bankruptcy screener for public companies based on Altman Z Score
{{corporate finance and investment banking
Corporate finance
Bankruptcy
Insolvency