The Value of Debt: How to Manage Both Sides of a Balance Sheet to Maximize Wealth

Chapter 2

The Basic Idea: Limiting the Costs, the Impacts, and the Duration of Financial Distress

Let us, now turn to the basic idea—the key theoretical and practical underpinning—of this book. It all begins with the notions of financial distress and the costs of financial distress, which are frequently turned to concepts when discussing the fortunes of companies.1 In this chapter these concepts—along with others that flow out of them—will be applied to individuals and families. We will then point out the many potential benefits of taking a more balanced approach to debt and of relying on one’s Indebted Strengths—Increased Liquidity, Flexibility, Leverage, and Survivability—to lessen the potential costs, impacts, and duration of financial distress.

For a company, then, according to Corporate Finance (Ross, Westerfield, and Jaffe 2013),

Financial distress is a term that defines the events preceding and including bankruptcy such as a violation of loan contracts. Financial distress is comprised of the legal and administrative costs of liquidation or reorganization (direct costs); and an impaired ability to do business and an incentive toward selfish strategies such as taking large risks, under-investing, and milking a property (indirect costs).

Throughout this book, financial distress, when applied to individuals and families, will mean much the same thing. That is, an individual or family will be said to be in financial distress when the individual or family has trouble honoring ...