Thursday, 24 May 2018

Financial Distress

The Financial Distress or financial hardship is a condition of the financial company is in trouble, crisis or not healthy that occurred before the company filed for bankruptcy. Financial distress occurs when a company fails or is no longer able to meet the obligations of the debtor because the experience lack and insufficiency of funds to initiate or continue his business again.

A company experiencing financial difficulties are generally experiencing a decrease in growth, kemampulabaan, and fixed assets, as well as an increase in inventory levels relative to healthy companies.

The financial Distress is also characterized by the presence of delay of delivery, the quality of the products is declining, and the delay bill payments from the bank. When the condition of financial distress is known, was expected to be carried out such actions to rectify the situation so that companies will not go on stage more severe difficulties such as bankruptcy or liquidation.


A Financial difficulties (financial distress) began when the company can not meet the payment schedule or when a cash-flow projection indicates that the company will soon be unable to meet its obligations .

The Financial distress or financial hardship can be defined as the inability of the companies to pay their financial obligations at maturity that caused the bankruptcy of the company.

Financial distress is the stage of decline experienced by the financial condition of a company, which occurs prior to the onset of insolvency or liquidation.

The financial distress is the State of financial difficulty or liquidity may be the beginning of the occurrence of bankruptcy.

Types and categories of Financial Distress

There are five forms of financial difficulties or financial distress, namely as follows:

  1. Economic failure. A State of the company's revenue is not able to close the company's total costs, including the cost of capital.
  2. Business failure. A State company stop operations with the aim of reducing the (result) of losses for creditors.
  3. Technical insolvency. A State company is not able to meet obligations due.
  4. Insolvency in bankruptcy. A State of the book value of total liabilities exceed the market value of the assets of the company.
  5. Legal bankruptcy. A State company is said to be bankrupt legally.

Generally divide the financial distress or financial hardship into four categories, as follows:

A. Financial distress category A (very high and actually harm)

This category allows the company to be declared bankrupt or bankrupt position. This category allows the parties the company reported to the relevant parties as the Court that the company has been in the position for bankruptcy (bankrupt). And submit a variety of affairs to be handled by parties outside the company.

B. Financial distress category B (high and considered harmful)

On the position of this company should be thinking about a variety of realistic solution in saving various owned assets, such as asset sources who want to sale and no sale/maintained. Including think of various impact if implemented the decision of the merger (the merger) and acquisitions (takeovers). One of the very real impact seen in this position is the company started doing layoff (Termination of employment) and early retirement on several employees who are considered not feasible (infeasible) again to be maintained.

C. Financial distress category C (medium and considered can still save yourself)

In these conditions the company should already be doing an overhaul of various policy and management concept that is applied for this, even if the need to do the recruitment of new experts who posses a high competence to be placed in positions the strategic control and salvage companies, including target acquisition boost profit in return.

D. Financial distress category D (low)

In this category the company considered only experienced temporary financial fluctuations that are caused by a variety of external and internal conditions, including the inception and implemented decisions less exact.

The Cause Of Financial Distress

The causes of financial difficulties or financial distress is explained in the Trinity of causes of financial difficulties, namely the following:

A. The Neoclassical model

Financial distress and bankruptcy occur if the resource allocation within the company. Less management can allocate resources (assets) that exist in the company for the activities of the company's operations.

B. Financial model

Mixing the asset right but wrong financial structure with liquidity constraints. This means that although the company can survive in the long run but he must also go bankrupt in the short term.

C. Corporate governance model

According to this model, the bankruptcy has a mix of assets and the right financial structure but poorly managed. The lack of efficient this push companies into of the market as a consequence of the problems in corporate governance are unsolved.

There are several other causes the onset of financial difficulties, especially at the small business group, namely the following:

Capital structure less

  • Lack of capital to buy capital goods and equipment.
  • Lack of capital to take advantage of goods supplies that are sold at a discounted quantity, or any type of other pieces.

B. Use of equipment and an outdated business methods

  • Failed to apply inventory control.
    Can't perform credit control.
    Less accounting records match it.

C. The absence of business planning

  • The inability to detect and understand the market changes.
    Inability to understand the changing economic conditions.
    Do not prepare plan for emergency situations or unpredictably.
    The inability to anticipate and plan for financial needs.

D. Personal Qualifications

  • Lack of knowledge of the business.
  • Don't want to work too hard.
  • Don't want to delegate tasks and powers.
  • Inability to maintain good relations with consumers.

How To Predict Financial Distress

Z-score or Altman Bankruptcy Prediction Model of Z-score is a model that gives the formula for assessing when the company will go bankrupt. Using the formula filled with financial ratios will be known to certain numbers that there is material to predict when the possibility the company will go bankrupt.

The formula for calculating the Z-Score for Model Altman's Z-score as follows:

Financial Distress Z Score Model


Xl = (current assets – debt smoothly) Asset/Total
X 2 = profit on hold/Total assets
X 3 = earnings before interest and taxes/Total Assets
X 4 = market value of common shares preferred book value total debt
X 5 = sales/ Total assets Zi = Z-Score values

Cut-off Values are Z < 1.81 company entered the category went bankrupt; Z-Score 1.81 < < 2.99 company enters grey area (grey area or zone of ignorance) or prone area and Z > 2.99 company doesn't go bankrupt.

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