What is Financial Distress?

A condition where a company cannot meet or has difficulty paying off its financial obligations to its creditors. The chance of financial distress increases when a firm has high fixed costs, illiquid assets, or revenues that are sensitive to economic downturns.

It is a tight cash situation in which a business cannot pay the owed amounts on the due date. If prolonged, this situation can force the owing entity into bankruptcy or forced liquidation. It is compounded by the fact that banks and other financial institutions refuse to lend to those in serious distress.

Why firms encounter financial distress?

Firms having high leverage ratio i.e having more debt and less equity. Firms in a declining industry i.e other firms also in the same industry are facing the same situation. Firms with inferior operating results.

What Happens in Financial Distress?

Filing for bankruptcy. Selling major assets. No more further credit from suppliers or other creditors Merging with another firm. Reducing capital spending and research and development. Layoffs Negotiating with banks and other creditors. Exchanging debt for equity., issuing new shares.

How can a firm come out of financial distress

Liquidation--- where you can sell your Non-profiting assets, and other assets that are not useful. Layoff--- You can layoff employees that are not useful to the organization, this improves the operating costs. Change the management--- If with the current management, it is not able to operate well then the management may be incapable.

Issue new securities--- You cant go for debt because banks wont give you finance, you can go for a FPO to issue new shares.
Speak to your creditors--- You can ask for more time to pay back your creditors.

If the firm has no other option then it has to File for bankruptcy