Financial distress is a condition in which a company cannot generate revenue or income because it is unable to meet or cannot pay its financial obligations. This is generally due to high fixed costs, illiquid assets, or revenues sensitive to economic downturns.
Ignoring the signs of financial distress can be devastating for a company. There may come a time when severe financial distress cannot be remedied because the company’s obligations are too high and cannot be paid, and there is just not enough revenue to offset the debt. If this happens, bankruptcy may be the only option.
Causes of Distress
A company move to a distress condition due to several reasons. Broadly these reasons can be classified into internal causes and external causes.
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- Managerial incompetences
- Heavy debt burden and resultant service cost
- Improper location
- Lack of financial discipline
- Technological failures
- Uneconomic plant size
- Over investments in fixed assets
- Unsuitable plant and machinery
- Poor emphasis on research and development
- Weak production and quality control
- Poor maintenance system
- Lack of marketing policy
- Weak demand projection
- Wrong product mix
- Improper product positioning
- Irrational price structure
- Inadequate sales promotion
- High distribution cost
- Poor customer service
- Wrong capital structure
- Wrong investment decisions
- Lack of financial policies
- Weak budgetary control
- Absence of responsibility accounting
- Inadequate management information system
- Poor management of receivables
- Bad cash planning and control
- Strained relationship with suppliers of capital
- Improper tax planning
- Ineffective leadership
- Poor labour relations
- Inadequate human resources
- Over staffing
- Lack of commitment on the part of employees
- Irrational compensation structure
- Lack of expenditure control system
- Excessive borrowings
- Conflict among key personnel
- Deteriorating quality.
The external environment may also affect the operations of a company adversely. Some of the major issues, which are generated by the external environment, are:
- Government policies regarding taxation, power tariff, power supply, customs duties and import duties, restrictions on imports and exports etc.
- Quota system imposed by the government on raw materials/ finished goods,
- The entry of a large number of firms thereby sudden increase in the capacity,
- Development of new technology,
- Sudden withdrawal by some of the major customers resulting into decline in orders,
- A change in the consumers’ tastes and preferences,
- Strained relationship with the external government,
- A change in the lending policies of financial institutions.
- Lack of proper maintenance of plant, machinery and equipment 8. Poor asset turnover
- A large accumulation of inventories
- Suppliers showing reluctance to offer trade discounts
- High labour turnover
- Extension of an accounting period
- Value erosion in respect of shares and debentures
- Declining market reputation
- Default in payment of statutory due.
A distressed person requires the assistance of another person to come out of the distressed state. Financial distress is also not a privilege to this principle. The action in this may come from the side of the person/organization in distress, banks, government, and voluntary enterprises. This process helped us to identify the following crucial situations for making the counselling process successful:
The client should feel that he is in a distressed situation and need assistance; The client should be willing to approach a counsellor.
The financial institutions can only catalysts for the counselling process, whereas the initiatives should come from the client’s side.
The client should enter into a contract with the counsellor that he would be devoted to implementing the solutions coming out of the process.
The client should divulge all his financial dealings to the counsellor in order to enable him to prepare different solutions so that the client can choose one among them.
The client should have confidence in the counsellor and should be prepared to work with him.
The client should understand that financial counselling is not consultancy and the counsellor is not committed to finding the financial assistance from any bank. The counsellor may only assist the client to make viable proposals and giving support to handle with the banks.
The financial counselling is not a debt recovery system. Hence the financial institutions searching for the assistance of counsellor s should not use their services for recovering loans because such a process will make a lack of confidence by clients on the counsellors.
The counselling is a regular process and the counsellor should be prepared to work with the client until he comes out of the crisis.
Financial counsellor s should have perfect knowledge of banking practices and procedures as also working on financial projects
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