Financial distress is a term in corporate finance used to indicate a condition when promises to

creditors A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property ...

of a

company A company, abbreviated as co., is a Legal personality, legal entity representing an association of people, whether Natural person, natural, Legal person, legal or a mixture of both, with a specific objective. Company members share a common p ...

are broken or honored with difficulty. If financial distress cannot be relieved, it can lead to

bankruptcy Bankruptcy is a legal process through which people or other entities who cannot repay 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 ...

. Financial distress is usually associated with some

cost In production, research, retail, and accounting, a 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 whic ...

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 Direct costs are costs which are directly accountable to a cost object (such as a particular project, facility, function or product). Direct cost is the nomenclature used in accounting. The equivalent nomenclature in economics is specific cost. By ...

include

auditor An auditor is a person or a firm appointed by a company to execute an audit.Practical Auditing, Kul Narsingh Shrestha, 2012, Nabin Prakashan, Nepal To act as an auditor, a person should be certified by the regulatory authority of accounting and a ...

fee A fee is the price one pays as remuneration for rights or services. Fees usually allow for overhead, wages, costs, and markup. Traditionally, professionals in the United Kingdom (and previously the Republic of Ireland) receive a fee in cont ...

s, legal fees, management fees and other payments. Cost of financial distress can occur even if bankruptcy is avoided (

indirect costs Indirect costs are costs that are not directly accountable to a cost object (such as a particular project, facility, function or product). Like direct costs, indirect costs may be either fixed or variable. Indirect costs include administration, ...

). Financial distress in companies requires

management Management (or managing) is the administration of an organization, whether it is a business, a nonprofit organization, or a government body. It is the art and science of managing resources of the business. Management includes the activities o ...

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 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 markets. Because ...

s increase the

interest rate An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, th ...

s if a state of financial distress occurs.

Options for relieving financial distress

If high

debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...

burden is the cause of financial distress, the company can undergo a

debt restructuring Debt restructuring is a process that allows a private or public company or a sovereign entity facing cash flow problems and financial distress to reduce and renegotiate its delinquent debts to improve or restore liquidity so that it can continue ...

. If operational issues are the reason for the distress, the company can negotiate a payment holiday with its creditors and improve operations to be able to service its debt. 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 website

Probability of bankruptcy screener for public companies based on Altman Z Score
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