Financial distress is a corporate finance term that refers to a situation where a company’s financial situation makes it difficult for them to pay their bills. This is especially applicable to loan repayments or paying creditor dues. If a company is going through severe or prolonged financial distress, there are chances it may go bankrupt.
Financial distress may occur due to various reasons. Here are some examples.Improper management decisions:Lehman Brothers was once the 4th largest investment bank in the USA. In 2008, the company filed for bankruptcy due to improper financial decisions. Fraud:Any practice of fraud may result in shifting the focus from maximizing shareholder’s wealth to benefiting the fraudster. Satyam Computers went under financial distress in 2009 due to reporting fictional expenses and profits.
Why it matters
Financial distress results in a situation under which a company cannot pay off its obligations. Management and stakeholders must therefore keep an eye on any prolonged improper planning, mismanagement, fraud, etc. within the company. The earlier a company recognizes such signs, the more chances that it can take necessary preventive action to avoid financial distress.