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IS "FINANCIAL DISTRESS IS DIFFERENT FROM INSOLVENCY"?

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Financial  Distress

■ Financial  distress  is  a  condition  where  a  company  cannot  meet,  or  has  difficulty  paying off,  its  financial  obligations  to  its  creditors,  typically  due  to  high  fixed  costs,  illiquid assets  or  revenues  sensitive  to  economic  downturns.  A  company  under  financial distress  can  incur  costs  related  to  the  situation,  such  as  more  expensive  financing, opportunity  costs  of  projects  and  less  productive  employees.

■ Employees  of  a  distressed  firm  usually  have  lower  morale  and  higher  stress  caused  by the  increased  chance  of  bankruptcy,  which  would  force them  out  of  their  jobs.

■ Poor  profits  indicate  a  company  is  not  experiencing  financial  health.  Struggling  to break  even  indicates  a  business  cannot  sustain  itself  from  internal  funds  and  needs  to raise  capital  externally.  This  raises  the  company's  business  risk  and  lowers  its creditworthiness  with  lenders,  suppliers,  investors  and  banks.  Limiting  access  to  funds typically  results  in a  company  failing.

■ Poor  sales  growth  or  decline  indicates  the  market  is  not  positively  receiving  a company's  products  or  services  based  on  its  business  model.  When  extreme marketing  activities  result  in  no  growth,  the  market  may  not  be  satisfied  with  the offerings,  and  the company  may  close down.

■ Likewise,  if  a  company  offers  poor  quality  in  its  products  or  services,  consumers  start buying from  competitors,  eventually  forcing a  business  to  close  its  doors.

■ When  debtors  take  too  much  time  paying  their  debts  to  the  company,  cash  flow  may be  severely  stretched.  The  business  may  be  unable  to  pay  its  own  liabilities.  The  risk is  especially  enhanced  when a  company  has  one or  two major  customers.

Financial Insolvency

Financial  distress  leads  to  Financial  insolvency.
Financial  insolvency  occurs  when  an  individual  or  a  firm  is  unable  to  meet  their  financial obligations.  Accounting  insolvency  happens  when  total  liabilities  exceed  total  assets (negative net  worth).

Financial  insolvency  involves  a  lack  of  liquidity  to  pay  debts  as  they  fall  due.  Insolvency  is not  a  synonym  for  bankruptcy,  which  is  a  determination  of  insolvency  made  by  a  court  of law  with  passing  legal  orders  intended to resolve  the insolvency.

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