Financial Management Tools

Abstract

Financial distress or related financial emergency is a term in Finance is a situation in which an organization faces extreme budgetary issues and battles in satisfying money related commitments, for example obligations, credit installments (Gabler-Wirtschaftslexikon, 2018). The term is utilized to show a condition when guarantees to loan bosses of a company are broken or respected with trouble. In the event that money related misery can’t be relieved, it will ultimately prompt indebtedness. Financial distress is typically associated with certain expenses to the organization. These are known as expenses of financial distress. Financial distress refers to a condition in which a company cannot meet, or has difficulty paying off, its financial obligations to its creditors, typically due to high fixed costs, illiquid assets, or revenues sensitive to economic downturns. Recent examples like the company Jack Wolfskin show that companies must anticipate and prevent a situation, which puts the company under stress (Handelsblatt, 2017). A financial crisis can be prevented and involves immediate actions and related negotiations with stakeholders like banks, employees, suppliers or investors. A company under financial distress can incur costs related to the situation, such as more expensive financing, opportunity costs of projects, and less productive employees. Employees of a distressed firm usually have lower morale and higher stress caused by the increased chance of insolvency, which threatens them to be forced out of their jobs. There are often alarm signals indicating the upcoming crisis as outline by various authors (Müller, 1986). Alarm signals like decreasing revenues, high operating cost and low profits usually indicate that a company is not in a good financial health situation. Struggling to reach profitability targets over a longer period indicates a business cannot sustain itself from internal funds and needs to raise capital externally. This raises the company’s business risk and significantly lowers its credit rating with banks, lenders, suppliers or investors. Limiting access to funds typically leads to liquidity issues and results often in a company failing as shown in Fig. 11.1 (Four phases model of Müller; Müller, 1986). Poor sales growth or decline indicates the market is not positively receiving a company’s products or services based on its business model. When extreme marketing activities result in no growth, the market may not be satisfied with the offerings, and the company may close down. Likewise, if a company offers poor quality in its products or services, consumers start buying from competitors, eventually forcing a business to close its doors. When debtors take too much time paying their debts to the company, cash flow may be severely stretched. The business may be unable to pay its own liabilities. The risk is especially enhanced when a company has one or two major customers. Müller describes four phases (see Fig. 11.1) from a strategic crisis, the profitability crisis, the liquidity crisis to the insolvency (Müller, 1986). The four phases of a financial crisis are described Müller by the strategic crisis, the profitability crisis, the liquidity crisis and the insolvency. Müller describes the strategic crisis as threat to the potential and substance of a company, which occur due to inadequate strategies in terms of differentiation, knowledge, innovation or cost advantages. In this strategic phase, market needs and elements are not fully taking into account, so that the foundation of the company is gradually weakening. In this situation, the symptoms are weak, the corrective actions are long-term and the need for actions is rather low compared to the following phases (Müller, 1986). The strategic phase is followed by the profitability crisis, which is characterised by signs of a weak financial performance in terms of revenues, cost, cash and profitability. Signs in this phase are stronger, often resulting in a loss, struggling to achieve targeted financial ratios or non-achievement of profit targets. The third phase is the liquidity crisis, in which a company is not capable of meeting its financial obligations anymore. This situation is severe as the cash situation and balance is not sufficient to pay the debts. As the credit rating decreases in this phase, companies tend to borrow money with higher interest rates or to prolong payments to suppliers, employees or banks where possible. The last phase of the model by Müller is the insolvency (Müller, 1986). Insolvency is the state of being unable to pay the money owed, by a person or company, on time. Those companies in a state of insolvency are said to be insolvent. There are two forms: cash-flow insolvency and balance-sheet insolvency. Cash-flow insolvency is when a person or company has enough assets to pay what is owed, but does not have the appropriate form of payment. For example, a person may own a large house and a valuable car, but not have enough liquid assets to pay a debt when it falls due. Cash-flow insolvency can usually be resolved by negotiation. For example, the bill collector may wait until the car is sold and the debtor agrees to pay a penalty. Balance-sheet insolvency is when a company does not have enough assets to pay all of their debts. The person or company might enter bankruptcy, but not necessarily. Once a loss is accepted by all parties, negotiation is often able to resolve the situation without bankruptcy. A company that is balance-sheet insolvent may still have enough cash to pay its next bill on time. However, most laws will not let the company pay that bill unless it will directly help all their creditors. For example, an insolvent farmer may be allowed to hire people to help harvest the crop, because not harvesting and selling the crop would be even worse for his creditors. In some jurisdictions, it is illegal under the insolvency laws for a company to continue in business while insolvent. In others (like the United States with its insolvency law and this chapter provisions), the business may continue under a declared protective arrangement while alternative options to achieve recovery are worked out. Increasingly, legislatures have favoured alternatives to winding up companies for good. The major focus of modern insolvency legislation in many countries and business debt restructuring practices no longer rests on the liquidation and elimination of insolvent entities but on the remodelling of the financial and organizational structure of debtors experiencing a financial crisis so as to permit the rehabilitation and continuation of their business. This is known as restructuring, business turnaround, financial crisis mitigation or business recovery. Implementing a business restructuring plan includes various measures and can be described.

Persistence is the twin sister of excellence. One is a matter of quality; the other, a matter of time.

Marabel Morgan