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What is meant by Financial Distress?
Financial distress is a situation in which a company cannot meet its obligations. In fact, companies borrow debts from investors for operations and growth. When the company performs badly, it may be unable to repay back the loans and funds it has borrowed from the lenders. This is called financial distress of the company.
There are many costs attached to financial distress. These may include costs related to employees, managers, customers, suppliers, and shareholders.
Costs Related to Employees
The employees of a distressed company are not confident. They are demoralized and worried about their future. This affects the quality of the products. The efficient managers start leaving the company which affects the reputation of the company. This may lead to a drop in sales of products.
Costs Related to Customers
Customers of a financially distressed firm may be afraid of its liquidation. They may be concerned about the quality of the products too. Moreover, as the service after sales get deteriorated, the customer base of the company starts to contract very fast. This erodes the value of the firm quickly.
Costs Related to Suppliers
Suppliers get concerned about the inability of financially distressed firms in meeting obligations. They discontinue granting credit to the firm fearing liquidation and liquidation problems of a financially distressed company. Creditors become aware of the company and start pressuring the company to liquidate to realize their claims.
Costs Related to Investors
During the financial distress of a company, its investors become concerned about the financial power of the company to meet its obligations. Investors stop investing in the firm that leads to a stoppage in operating funds of the company. The investors also start to claim more interest rates if they offer credit to financially distressed firms. Therefore, the companies find it very hard to run their businesses with the increasing need for funds and less availability of it.
Costs Related to Shareholders
Shareholders usually take a different point of view when a company is in financial distress. They may stay invested in the company taking the risk. The risk may return substantial profits if the company can recover its position and hence the shareholders wait for the ultimate result of the state of a financially distressed firm.
To conclude, it is obvious that the road ahead for financially distressed companies is full of obligations and hurdles. It becomes very hard for financially distressed companies to get back to normal and become financially stable within a short term. However, many examples of financially distressed companies achieving success exist and it is not an impossible task to get back to being a profit-making company from being financially distressed.
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