Fundamentals of Financial Management, Third Edition

24.1 CONCEPT OF FINANCIAL DISTRESS

Financial distress, which is often referred to as financial failure, is a broad term and it can be interpreted in different ways. They are as follows:

1. Economic failure
2. Financial failure that includes,
   1. Illiquidity
   2. Insolvency

Economic failure occurs where the firm’s revenue is not sufficient to cover its costs or when the internal rate of return (irr) is less than the firm’s cost of capital.

24.1.1 Economic Failure

Here the word, “failure” does not mean a firm’s dissolution or collapse. Economic failure occurs where the firm’s revenue is not sufficient to cover its costs or when the internal rate of return (IRR) is less than the firm’s cost of capital. In other words, it can be said that economic distress ...