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What is Financial Distress?

A situation where a firms operating cash flows are not sufficient to satisfy current
obligations and the firm is forced to take corrective action.
Financial distress may lead a firm to default on a contract, and it may involve financial
restructuring between the firm, its creditors, and its equity investors.
Definition of Terms
Default
-failure to meet an interest payment or, -violation of debt agreement
Bank ruptcy
--formal procedure for working out default ,- does not automatically follow from default
Financial Distress
Includes default and bankruptcy, but also,- threat of default or bankruptcy and its effect
on the company. Defined to capture the cost and benefits of using large amounts of debt
finance.
INSOLVENCY
Stockbase insolvency; the value of the firms assets is less than the value of the debt.
SOLVENT FIRM
DEBT
EQUITY
ASSETS

DEBT
ASSETS
INSOLVENT FIRM

Insolvency
Flowbase insolvency occurs when the firms cash flows are insufficient to cover
contractually required payments.

Responses to Financial Distress

Think of the two sides of the balance sheet.
Asset Restructuring:
Selling major assets.
Merging with another firm.
Reducing capital spending and R&D spending.
Financial Restructuring:
Issuing new securities.
Negotiating with banks and other creditors.
Exchanging debt for equity.
Filing for bankruptcy.
Bankruptcy Liquidation and Reorganization
Malaysias Bankruptcy Act 1967 is based on the English Bankruptcy Act of 1914.
A debtor is defined in Section 3(3) BA 67 to include those personally present in
Malaysia, ordinarily resident or had a place of residence in Malaysia, was carrying on
business in Malaysia either personally or by means of an agent, or was a member of a
firm or partnership which carried on business in Malaysia.
Liquidation Value
Liquidation value represents the price at which each individual asset can be sold if
business operations are discounted in the wake of liquidation of the firm. In operation
terms, the liquidation value of a business is equal to the sum (i) reliable value of assets
and (ii) cash and bank balance minus the payments required to discharge all external
liabilities..
In general among all measures of value the liquidation value of an asset / or business is
likely to be the least.
Definition of 'Bankruptcy
A legal proceeding involving a person or business that is unable to repay
outstanding debts.
The bankruptcy process begins with a petition filed by the debtor (most common)
or on behalf of creditors (less common).
All of the debtor's assets are measured and evaluated, whereupon the assets are
used to repay a portion of outstanding debt.
Upon the successful completion of bankruptcy proceedings, the debtor is relieved
of the debt obligations incurred prior to filing for bankruptcy.