Question

Explain the three major approaches to resolve financial distress?

Answer 1

Financial distress is the situation in which the company or individual cannot generate revenue or income because it cannot pay its financial obligation .it can be because of high fixed cost or expenses could be more. If a company or individual experiences a period of time when it cannot pay its bills and other obligations by their due date, it is likely experiencing financial distress. Looking at a company's financial statement can help investors and others determine its financial health. The below point help the company or individual to overcome the financial distress.

• Had more financial predictability

• Could teach your team to understand the finances

• Could rely on your team to help improve the bottom line

• Had a common purpose that aligned everyone

• Could impact the lives of your employees and interns by teaching them financial literacy

Best approaches to the financial distress

• Review business plan or budget and build new budget with innovative idea
• Cut the cost by reduce employee, reduce inventory cost ,cut down the management incentive
• Improve the liquidity of the firm by reconstructing the debtors with new repayment terms
• Individual finance stress could be solved by cut back on unnecessary or excessive spending habits such as dining out, travel, and other purchases that may be deemed a luxury
• By raising new share or debenture will help the company to find the fund for its long term and short term obligation. This will help the company to overcome the financial distress
• Financial director should reconstruct the company capital structure &leverage
• Find the load or debt with less interest rate
• Learn to forecast –Forecasting helps create more predictable financial outcomes. It provides you more confidence in making a capital purchase, hiring new staff or investing in a new product
• financial planning -
• financial control

Finance manager should take the below decision intelligently during the financial distress

Investment decision:

The Finance manager involved in the following investment decisions:

(a) Ascertainment of total volume of funds, a firm can commit.

(b) Appraisal and selection of capital investment proposals.

(c) Measurement of risk and uncertainty in the investment proposals.

(d) Prioritizing of investment decisions.

(e) Funds allocation and its rationing.

(f) Determination of fixed assets to be acquired.

(g) Determination of levels of investments in current assets viz., inventory, receivables, cash, marketable securities etc., and its management.

(h) Buy or lease decisions.

(i) Asset replacement decisions.

(j) Restructuring, reorganization, mergers and acquisitions.

(k) Securities analysis and portfolio management etc

Finance decision

The Finance manager involved in the following finance decisions:

(a) Determination of degree or level of gearing.

(b) Determination of financing pattern of long-term funds requirement.

(c) Determination of financing pattern of medium and short-term funds requirement.

(d) Raising of funds through issue of financial instruments viz., equity shares, preference shares, debentures, bonds etc.

(e) Arrangement of funds from banks and financial institutions for long-term, medium-term and short-term needs.

(f) Arrangement of finance for working capital requirement.

(g) Consideration of interest burden on the firm.

(h) Consideration of debt level changes and its impact on firm’s bankruptcy.

(i) Taking advantage of interest and depreciation in reducing the tax liability of the firm.

(j) Consideration of various modes of improving the earnings per share and the market value of the share.

(k) Consideration of cost of capital of individual components and weighted average cost of capital to the firm.

(l) Analysis of impact of different levels of gearing on the firm and individual shareholder.

(m) Optimization of financing mix to improve return to the equity shareholders and maximiza­tion of wealth of the firm and value of the shareholders’ wealth.

(n) Portfolio management.

(o) Consideration of impact of over capitalization and under capitalization on the firm’s profitability.

(p) Consideration of foreign exchange risk exposure of the firm and decisions to hedge the risk.

(q) Study of impact of stock market and economic conditions of the country on modes of financing.

(r) Maintenance of balance between owners’ capital to outside capital.

(s) Maintenance of balance between long-term funds and short-term funds.

(t) Evaluation of alternative use of funds.

(u) Setting of budgets and review of performance for control action.

(v) Preparation of cash-flow and funds flow statements and analysis of performance through ratios to identify the problem areas and its correction, etc.

Dividend decision

The Finance manager will involve in taking the following dividend decisions:

(a) Determination of dividend and retention policies of the firm.

(b) Consideration of impact of levels of dividend and retention of earnings on the market value of the share and the future earnings of the company.

(c) Consideration of possible requirement of funds by the firm for expansion and diversification proposals for financing existing business requirements.

(d) Reconsideration of distribution and retentions policies in boom and recession periods.

(e) Considering the impact of legal and cash-flow constraints on dividend decisions.