Financial distress

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Financial distress is a term in Corporate Finance used to indicate a condition when promises to creditors of a company are broken or honored with difficulty. Sometimes financial distress can lead to bankruptcy. Financial distress is usually associated with some costs to the company and these are known as Costs of Financial Distress. A common example of a cost of financial distress is bankruptcy costs.

In a more general sense, financial distress is a reduction in financial efficiency that results from a shortage of cash. This concept applies even to individuals and households. Imagine that you have no preference about what kind of toilet paper you use, so you simply buy the cheapest toilet paper available. This means you go to a big box store every few months and buy in bulk. But to take advantage of the lowest price, you have to buy a large quantity and spend several dollars. Now imagine that you were short on cash as your toilet paper was running low. You cannot afford to buy in bulk, so you buy a small package at a convenience store. In order to minimize your total cash outlay, you accept a higher unit cost. That's what happens in financial distress. You're too poor to live cheaply.

[edit] Debt Restructuring

Debt restructuring is the process that allows a private or public company - or a sovereign entity - facing cash flow problems and financial distress, to reduce and renegotiate its deliquent debts in order to improve or restore liquidity and rehabilitate so that it can continue its operations.

[edit] 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
• The Costs of Financial Distress across Industries by Arthur Korteweg

Financial distress cost are divided into: direct costs

                                       :  indirect costs

Direct Costs -changes the payout to debtholders if bankruptcy occurs. these include the direct expenses that a company inccurs; auditors' fees, legal fees, management fees and other payments.

Indirect Costs -changes the distrubition of firm value prior to bankruptcy. these include loss goodwill. which will result in less sales, hence revenue