How is financial distress defined?

Financial distress is defined as a situation where a company cannot meet its financial obligations. This occurs when a firm's cash flow is insufficient to cover its debts, leading to potential bankruptcy or requiring intervention such as restructuring. In financial distress, a company may struggle to pay interest on loans, repay principal amounts, or manage essential operational costs, which can seriously undermine its viability and attract creditors' scrutiny.

Understanding financial distress is vital for stakeholders, including investors and creditors, as it signals that the organization may be at risk of insolvency or defaults. Recognizing the signs of financial distress early allows for proactive measures to be taken, which could involve financial restructuring, renegotiation of debt terms, or exploring new capital avenues to stabilize the company's financial position.