What Is Financial Distress?

an emergency exit sign on an orange wallWhat Is Financial Distress?

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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Internal Causes

  1. Managerial incompetences
  2. Heavy debt burden and resultant service cost
  3. Improper location
  4. Lack of financial discipline
  5. Technological failures
  6. Uneconomic plant size
  7. Over investments in fixed assets
  8. Unsuitable plant and machinery
  9. Poor emphasis on research and development
  10. Weak production and quality control
  11. Poor maintenance system
  12. Lack of marketing policy
  13. Weak demand projection
  14. Wrong product mix
  15. Improper product positioning
  16. Irrational price structure
  17. Inadequate sales promotion
  18. High distribution cost
  19. Poor customer service
  20. Wrong capital structure
  21. Wrong investment decisions
  22. Lack of financial policies
  23. Weak budgetary control
  24. Absence of responsibility accounting
  25. Inadequate management information system
  26. Poor management of receivables
  27. Bad cash planning and control
  28. Strained relationship with suppliers of capital
  29. Improper tax planning
  30. Ineffective leadership
  31. Poor labour relations
  32. Inadequate human resources
  33. Over staffing
  34. Lack of commitment on the part of employees
  35. Irrational compensation structure
  36. Lack of expenditure control system
  37. Excessive borrowings
  38. Conflict among key personnel
  39. Deteriorating quality.

External Environment

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:

  1. Government policies regarding taxation, power tariff, power supply, customs duties and import duties, restrictions on imports and exports etc.
  2. Quota system imposed by the government on raw materials/ finished goods,
  3. The entry of a large number of firms thereby sudden increase in the capacity,
  4. Development of new technology,
  5. Sudden withdrawal by some of the major customers resulting into decline in orders,
  6. A change in the consumers’ tastes and preferences,
  7. Strained relationship with the external government,
  8. A change in the lending policies of financial institutions.
  9. Lack of proper maintenance of plant, machinery and equipment 8. Poor asset turnover
  10. A large accumulation of inventories
  11. Suppliers showing reluctance to offer trade discounts
  12. High labour turnover
  13. Extension of an accounting period
  14. Value erosion in respect of shares and debentures
  15. Declining market reputation
  16. 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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