Financial Distress: Major Signs, Sources, & Ways to Eliminate Them

ABSTRACT

This paper looks upon the issue of financial distress as many companies or individual projects run within the company face the issue. Financial distress, how it is defined in various literature, major signs of distress, methods used in detecting the distress, potential sources of financial distress, and feasible ways in eliminating distress factors are the topics constituting this paper. Financial statements are the main tools in the prediction process as selected ratios are chosen for forecasting the distress. Altman's z-score, which itself could be cited as a byproduct of financial statements, is specifically mentioned here as one of the most used and reliable ways for looking into the future of the company and making valuable assessment in prediction of financial distress and infliction point. Moreover, one could look into the change in the direction of Z-score in addition to perceiving the score as an absolute value. Though the fluctuations and disruptions in cash flows are noted as the cause of distress, one should not forget that the economic cycle and the macroeconomic factors as a whole are some of the main and leading causes of disruptions in cash flows. Macroeconomic factors are indicated as the cause and fluctuations in cash flows are the effect. The remaining part of the paper discusses ways to eliminate the risks influencing and fluctuating cash flows. Some of these methods are change in managerial methods and using financial tools and options which protect the project against uncertainties.

Keywords: financial distress, prediction, Altman, Z-score, bankruptcy, failure, net present value, negative cash flow, insolvency, macroeconomic factors, negative net present value, NPV

Source : Azadinamin, Amirsaleh, Financial Distress: Major Signs, Sources, & Ways to Eliminate Them (September 21, 2012). Available at SSRN: http://ssrn.com/abstract=2149966