financial distress

financial distress
The situation in which the activity of a business is influenced by the possibility of impending insolvency. The costs of distress can be divided into those related to bankruptcy and those incurred without bankruptcy. The costs of bankruptcy are those directly incurred in winding up or restructuring the business. The costs short of bankruptcy are those arising from a sudden change in suppliers' and customers' behaviour, prompted by their concerns over dealing with a potentially insolvent firm. They also include costs engendered by the diversion of managerial focus and conflicts between stakeholders, notably managers, debt holders, and shareholders. As a firm increases the level of its debt or gearing, so the costs of financial distress will rise (and hence the cost of funding). The costs of financial distress are an important factor in determining the firm's level of gearing.

Accounting dictionary. 2014.

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