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What Is Financial Distress?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 29 September 2014
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As it relates to businesses, financial distress is an economic situation where a corporation is undergoing increasing difficulty in honoring its debt obligations in a timely manner. If left unchecked, the distress can eventually reach a point at which the business is unable to meet those obligations. At that point, the company is likely to take several different measures to relieve the stress, including selling off assets or possibly declaring bankruptcy.

There are a number of reasons why a business may experience financial distress. In some cases, the problem is poor management of assets, leading to situations where the revenue generated by the business is diverted into projects that ultimately do not generate any type of return. At other times, the management may be due to overestimating projected income and functioning with an operating budget that is not realistic. With these types of causes for financial distress, reworking the budget and eliminating waste will often help the company move out of the crisis and be able to pay bills on time without a great deal of hardship.

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Financial distress may also occur due to unforeseen factors that have an adverse effect on the different revenue streams that the corporation enjoys. For example, an unfavorable outcome in a political election or the occurrence of a natural disaster may undermine the value of securities held by the business. This effectively reduces the revenue stream that the corporation may have depended on to cover its expenses. When situations of this type arise, trimming expenses as much as possible will often ease the financial distress and allow the company to avoid bankruptcy, or even the need to sell off distressed securities that are likely to increase in value in a reasonable amount of time.

In some situations, the financial distress may be so great that the business must either liquidate or undergo bankruptcy as a way of relieving the stress. The bankruptcy action may be necessary to protect the business from creditors while the company is reorganized under the direction of the courts, allowing the corporation to at least have a chance of getting back on a firm financial foundation. Liquidation may be partial or complete, depending on the amount of debt involved. With a partial liquidation, the business sells off assets, including divisions of the business, that are not needed for the continued operation of the core businesses. A complete liquidation means the selling of all assets and the eventual dismantling of the company as a business entity.

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nony
Post 6

@everetra - The fact is that all businesses can experience financial distress as part of the business cycle, not owing to poor management or anything like that. It’s simply the economy.

During bust cycles, retail businesses don’t do as well. People aren’t eating out as much. Everybody is penny pinching and looking at their bottom line.

During boom periods it can be just the opposite. Businesses that survive all economic cycles need to have good backup plans. They need to conserve cash so that they can survive the lean years, and grow aggressively during the prosperous years, in my opinion.

everetra
Post 5

@Charred - I worked for a telecommunications company too. Our company experienced financial difficulty as well. I don’t attribute it to general problems in telecommunications, however.

I attribute it to poor management – or more like corrupt management. Our CEO was found guilty of cooking the books and the SEC hit us hard. The stocks took a nosedive as investors fled like crazy.

We tried other measures to stave off the inevitable mad rush towards bankruptcy. We sold a whole bunch of our fiber assets but even that wasn’t enough. Eventually the company filed for bankruptcy and got bought out by one of the bigger boys. A lot of people lost their jobs in the process.

Charred
Post 4

I lived through the big dot com bubble and subsequent bust. I know all about financial distress costs and its impact on a business. One of the telecommunications companies that I worked for was not doing so well.

It was one of the smaller telecoms but it simply couldn’t compete with the big boys, even after the breakup of the Bells and deregulation. They were still able to sell residential phone service at much lower rates than we were.

In telecom, there is also the added burden of a high customer churn rate. Customers are switching providers about every six months or so, because they find cheaper rates. At some point there is simply no way that you can keep up. It got so bad that we filed bankruptcy twice.

It was Chapter 11 both times, so we were still able to remain in business. Eventually we got bought by a bigger company.

John57
Post 3

@Mykol - I can understand the financial distress your brother has gone through. I had always been a stay at home mom, but have had to go back to work so our family could have insurance benefits.

The company my husband worked for laid a lot of people off, and he was one of them. Even though the company is in a lot of financial debt, they are still in business but running on a skeleton crew.

In times like this it takes the cooperative effort of everyone to make it through. When companies suffer financial distress, that also affects all the families that work for that company.

It seems that business financial distress and relationship and family stress go hand in hand.

Mykol
Post 2

My brother is in business for himself building homes, and he has been hit hard the last few years.

The housing market has really taken a hit, and this has had a huge financial impact on his family.

He went from having more houses to build than he had time for, to absolutely nothing. It has been over 2 years since he has had a contract to build a new house.

Consequently, he had to file bankruptcy and has had to get get his whole life in order. This has taken quite a toll on his family. He is trying to get started in another line of work, but it has been a slow process.

andee
Post 1

There have been many companies who have undergone recent financial distress. You never think too much about it until it hits close to home.

My daughter worked at a daycare center that ended up closing because of financial distress. Looking back now, you can see there were some red flags leading up to this, but it still came as quite a shock to the employees and parents of the kids.

The first big red flag was when one of her payroll checks didn't clear. This was smoothed over and eventually she got her money, but it wasn't long after that when the doors closed.

The biggest reason this business failed was because of poor management and over extending of resources.

The cost of financial distress usually affects a lot more people than the owner of the company. In this case there were a lot of employees out of a job and parents who wondered who was going to take care of their kids.

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