What is Financial Distress?

Financial distress occurs when a company cannot meet its financial obligations and payment deadlines. It can be caused by a variety of factors, including economic downturns, changes in the industry, or mismanagement of resources.

Financial distress can be a very stressful and emotional experience for business owners. It can be incredibly challenging if the business is closely tied to the owner’s identity and self-worth. The fear of failure and the uncertainty of the future can be overwhelming and lead to feelings of anxiety, depression, and even hopelessness. In addition to the emotional toll, financial distress can also take a physical toll on business owners.

Stress Manifestations

It can cause sleep problems, appetite changes, and physical health problems. It is vital for business owners to take care of their mental and physical health during this challenging time and to seek support from experts.

Family Stress

Stress from not having enough money might make it difficult for family members to get along. When business owners experience stress about making ends meet, they may withdraw emotionally and become focused on work. If the company is the family’s primary source of income, this may be extremely challenging. Financial worries and stress can affect communication and understanding among families.

Poor Decision Making

A deterioration in the state of the economy, increased levels of rivalry from other companies, or ineffective management of financial resources are a few of the many potential triggers for monetary difficulties. Inadequate accounts receivable and inventory management can make it hard for businesses to make money. The accumulation of debt and the inability to meet financial obligations on time are two potential outcomes of poor financial decisions. Troubles with money easily snowball into a negative cycle that is tough to escape.

The Cost of Financial Distress

Indirect Costs

Companies with a lot of debt pay less attention to management and operations because they have to deal with financial issues. The cost of acquiring capital rises, compounding the burden of debt service. Financial distress can also lead to legal and administrative costs associated with the restructuring process. Hiring financial advisors, lawyers, accountants, and other professionals may be necessary to solve these problems. In addition, the company’s reputation and image may suffer, leading to potential customer losses that result in further financial hardship.

Direct Costs

If business bankruptcy is the result of financial distress, then there are many fees attached, such as:

  • Legal fees
  • Lawyer fees
  • Management fees
  • Auditor fees
  • Financial advisor fees
  • Filing fees
  • Financial restructuring fees
  • Liquidation costs

Companies do not often survive business bankruptcy, and small businesses find it difficult to even raise the funds to pay for the filings. The Wall Street Journal ran a story in March of 2018 called, “Bankruptcy Is Often Too Costly for Small Businesses, Senate Panel Hears”

Lenders with no other option may be forced to take legal action against debtors who refuse to pay debts. Ignoring financial problems can also lead to insolvency proceedings, and the company may be subject to liquidation. In this case, creditors will attempt to recover their investments by disposing of assets or restructuring the debt obligations of the business.