As it relates to businesses, financial distress is an economic situation where a corporation is undergoing increasing difficulty in honoring its debt obligations in a timely manner. If left unchecked, the distress can eventually reach a point at which the business is unable to meet those obligations. At that point, the company is likely to take several different measures to relieve the stress, including selling off assets or possibly declaring bankruptcy.
There are a number of reasons why a business may experience financial distress. In some cases, the problem is poor management of assets, leading to situations where the revenue generated by the business is diverted into projects that ultimately do not generate any type of return. At other times, the management may be due to overestimating projected income and functioning with an operating budget that is not realistic. With these types of causes for financial distress, reworking the budget and eliminating waste will often help the company move out of the crisis and be able to pay bills on time without a great deal of hardship.
Financial distress may also occur due to unforeseen factors that have an adverse effect on the different revenue streams that the corporation enjoys. For example, an unfavorable outcome in a political election or the occurrence of a natural disaster may undermine the value of securities held by the business. This effectively reduces the revenue stream that the corporation may have depended on to cover its expenses. When situations of this type arise, trimming expenses as much as possible will often ease the financial distress and allow the company to avoid bankruptcy, or even the need to sell off distressed securities that are likely to increase in value in a reasonable amount of time.
In some situations, the financial distress may be so great that the business must either liquidate or undergo bankruptcy as a way of relieving the stress. The bankruptcy action may be necessary to protect the business from creditors while the company is reorganized under the direction of the courts, allowing the corporation to at least have a chance of getting back on a firm financial foundation. Liquidation may be partial or complete, depending on the amount of debt involved. With a partial liquidation, the business sells off assets, including divisions of the business, that are not needed for the continued operation of the core businesses. A complete liquidation means the selling of all assets and the eventual dismantling of the company as a business entity.
