Business Failure

 A situation in which a company or other business ceases operations

because it is unable to generate sufficient revenue to cover its
expenses. Business failure is relatively common in the first year or
so of operations because the owner is unable to compete for any
number of reasons.
 What are the kinds of business failure?
 Businesses can fail as a result of wars, recessions, high taxation,
high interest rates, excessive regulations, poor management
decisions, insufficient marketing, inability to compete with other
similar businesses, or a lack of interest from the public in the
business's offerings.
 What Is Financial Distress?
 Financial distress is a condition in which a company or
individual cannot generate revenue or income because it is
unable to meet or cannot pay its financial obligations. This is
generally due to high fixed costs, illiquid assets, or revenues
sensitive to economic downturns.
Financial distress: is the situation when a company’s inability to fulfill its debt obligation to the
third parties and that leads to either restructuring or bankruptcy.
Ignoring the signs of financial distress can be devastating for a
company. There may come a time when severe financial
distress cannot be remedied because the company or
individual's obligations are too high and cannot be paid, and
there is just not enough revenue to offset the debt. If this
happens, bankruptcy may be the only option.

 Understanding Financial Distress

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. Some of these expenses may
include (expensive) financing, opportunity costs of projects, and
employees who aren't productive. Employees of a distressed firm
usually have lower morale and higher stress caused by the
increased chance of bankruptcy, which could force them out of their
jobs.

Companies under financial distress may find it difficult to

secure financing. They may also find their market value
dropping significantly, customers cutting back orders, and
suppliers changing their terms of delivery.
Looking at a company's financial statement can help investors and
others determine its financial health. For example, negative cash
flow under the cash flow statements is one indicator of financial
distress. This could be caused by a big difference between cash
payments and receivables, high interest payments, and a drop in
working capital.

Individuals who experience financial distress may find themselves in

a situation where their debts are much more than their monthly
income. This includes home or rent payments, car payments, and
credit card and utility bills. People who experience situations like
these tend to go through it for an extended period of time.
 Signs of Financial Distress
There are multiple warning signs to indicate a company is
experiencing financial distress. Poor profits may indicate a company
is financially unhealthy. Struggling to break even indicates a
business cannot sustain itself from internal funds and needs to
raise capital externally. This raises the company’s business risk and
lowers its creditworthiness with lenders, suppliers, investors, and
banks. Limiting access to funds typically results in a company (or
individual) failing.

Poor sales growth or decline indicates the market is not

positively receiving a company’s products or services based
on its business model. When extreme marketing activities
 result in no growth, the market may not be satisfied with the
offerings, and the company may close down. Likewise, if a
company offers poor quality products or services, consumers
start buying from competitors, eventually forcing a business to
close its doors.
When debtors take too much time paying their debts to the
company, cash flow may be severely stretched. The business or
individual may be unable to pay its own liabilities. The risk is
especially enhanced when a company has one or two major
customers.

KEY TAKEAWAYS

 Financial distress happens when a company or individual

cannot generate revenue or income and can't meet or pay its
financial obligations.
 Financial distress is usually the last step before bankruptcy.
 In order to remedy the situation, a company or individual may
consider options such as restructuring debt or cutting back on
costs.
 What are the various level or degrees of financial distress?

The degree of financial leverage is a financial ratio that measures

the sensitivity in fluctuations of the company’s overall profitability
to the volatility of its operating income caused by changes in
its capital structure. The degree of financial leverage is one of the
methods used to quantify a company’s financial risk (the risk
associated with how the company finances its operations).
What is Financial Leverage

Financial leverage is the main source of financial risk. By issuing

more debt, the company incurs the fixed costs associated with the
debt (interest payments). The company’s inability to meet the
obligations may result in financial distress or even bankruptcy.

Highly leveraged companies may face significant financial

problems during a recession because their operating income will
rapidly decline and, thus, so will their overall profitability. Note
that taxes do not affect the degree of financial leverage.

A high degree of financial leverage indicates that even a small

change in the company’s leverage may result in a significant
fluctuation in the company’s profitability. Also, a high degree of
leverage may translate to a more volatile stock price because of
the higher volatility of the company’s earnings. Increased stock
price volatility means the company is forced to record a higher
expense for outstanding stock options, which represents a higher
cost of debt. Therefore, companies with extremely volatile
operating incomes should not take on substantial leverage
because there is a high probability of financial distress for the
business.
Formula for Degree of Financial Leverage

There are several ways to calculate the degree of financial

leverage. The choice of the calculation method depends on the
goals and context of the analysis. For example, a company’s
management often wants to decide whether it should or should
not issue more debt. In such a case, net income would be an
appropriate measure of the company’s profitability:
However, if an investor wants to determine the effects of the
company’s decision to incur additional leverage, the earnings per
share (EPS) is a more appropriate figure because of the metric’s
strong relationship with the company’s share price.

Finally, there is a formula that allows calculating the degree of

financial leverage in a particular time period:

Example of Degree of Financial Leverage

ABC Corp. is preparing to launch a new project that will require

substantial external financing. The company’s management wants
to determine whether it can safely issue a significant amount of
debt to finance the new project. Currently, the company’s EBIT is
$500,000, and interest payments are $100,000.

In order to make the decision, the company’s management wants

to examine the degree of financial leverage ratio:
It shows that a 1% change in the company’s leverage will change
the company’s operating income by 1.25%.

 What would be the consequence of financial distress?

POSSIBILITY AND CONSEQUENCES OF FINANCIAL DISTRESS

Growth is not inevitable, and firms may not remain as

going concerns. In fact, even large publicly traded firms
sometimes become distressed for one reason or another
and the consequences for value can be serious. In this
section, we consider first how common it is for firms to
become distressed and follow up by looking at the
consequences of distress.
 Possibility of Distress
Financial distress is far more common in the real world
that most of us assume it to be. In fact, even casual
empirical observation suggests that a very large number of
firms, especially smaller and higher-growth ones, will not
survive and will go out of business. Some will fail because
they borrow money to fund their operations and then are
unable to make these debt payments. Other will fail
because they do not have the cash to cover their
operating needs.
Employee Equity Options and Compensation
In recent years, many firms have shifted toward equity-
based compensation for their employees. It is not
uncommon for firms to grant millions of options annually
not only to top managers but also to lower-level
employees. These options create a potentially value-
decreasing overhang over common stock values. What
used to be a simple practice of dividing the estimated
equity value by the number of shares outstanding to arrive
at value per share has become a daunting exercise.
Analysts struggle with how best to adjust the number of
shares outstanding (and the value per share) for the
possibility that there will be more shares outstanding in the
future. They attempt to capture this dilution effect by using
the partially diluted or fully diluted number of shares
outstanding in the company. As we will see in this chapter,
these approaches often yield misleading estimates of
value per share, and we propose a sounder way of dealing
with employee options.
We also explore other forms of equity compensation,
including the use of restricted and unrestricted stock
grants to management, and the effects of such grants on
value per share. Like options, these stock grants reduce
the value of equity to existing stockholders and have to be
considered in valuation.
 What are the major formal and informal means of
solving financial distress? Explain them with example.
This paper investigates the determinants of the arbitration taking place after a
corporate defaults. Two ways of resolving financial distress are conceivable: either
the creditors privately renegotiate with the debtor, or a formal bankruptcy procedure
is triggered. This arbitration depends on the legal context and, more specifically, on
the national bankruptcy code. We use original data coming from the recovery units
of five French commercial banks. Our sample gathers 735 credit lines allocated to
386 distressed companies. We test four hypotheses. Hypothesis H1 proposes that
bargaining power imbalances may have more impact on the arbitration than simple
coordination failures, especially under court-administered legislation. Hypothesis H2
suggests that, to initiate the process of renegotiation, a bank needs information on
the project’s profitability and on the managers’ reliability. To reach an agreement,
the bank must ensure that both the conditions have been met. Hypothesis H3
predicts that the likelihood of renegotiation increases with the bank’s financial
involvement. Hypothesis H4 focuses on the level of collateralization: when the bank
has inclination for liquidation, collaterals may increase the occurrence of bankruptcy,
provided the law facilitates such liquidation and preserves the bank’s priority. For
testing the hypotheses H1 to H4, we use sequential LOGIT modeling to split
between the variables explaining the decision to engage (or not) renegotiation and
the variables explaining the success (or the failure) of renegotiation. Regarding H1,
we find that even a court-administered procedure may not be dissuasive provided
that the bank’s bargaining power is strong enough. Regarding H2, we show that the
profitability of the project and the reliability of the managers are two essential
conditions for avoiding bankruptcy. However, it takes some time to discover them.
Regarding H3, our estimates show that, when the lending is bigger and/or when the
debt contract is longer, then the chances of renegotiation are higher, but this does
not predict such renegotiation shall be successful. Last, regarding H4, we do not find
any evidence that the level of collateralization influences the arbitration between
renegotiation and bankruptcy

WHAT IT MEAN BUSSINES FALIURE

A situation in which accompany or other business ceases operational because it is unable to

generated sufficient revenues to cover expense for example if the company is un able to services it
may file for bankruptcy & stop operating

Business failure is relatively common in the first year or so operation s because of the owner is unable
to compete for any numbers of reasons.

They most common business failure

  Lack of capital or funding
 Retaining an inadequate management team
 Faulty infrastructure or business model
 Un successful marketing initiative

Factors that lead to business failures

There are different factor which lead to business failures among them same are listed under this
topics those situation just cause business failures form time to time in organization or
environmental satiations.

 Not seeking professional advice

 Lack of good customer service
 Lack of experience
 Un accountability
 Lack of personal growth
 Poor location
 Lack of focus
 Wrong expectation
 Quitting too soon

NOT SEEKING PROFESSIONAL ADVICE

One of the best pieces of advice it can give to any one business never stop learning read & learn about
marketing. Due to this result business person seeking advice regarding to it professional

LACK OF GOOG CUSTOMER CARE

It very important that you make your customer care a priority because of A business with good
customer care grows. Good customer care brings return customer & return customer bring referral
customer.

COPYING OTHERS

 Many people have gone into business or made a business choice because they see others
doing it & think they can be successful in it if they try.

LACK OF EXPERIENCE.

 It is one of the cause of business failure

 If you are inexperienced or your management made up of novices.
 UNACCOUNTABILITY

 You must be accountable for any dime your business makes. Most of the time any
entrepreneurs could not account for daily sales for that reason business failures happened.

LACK OF PROFESIONAL GROWTH

 Many entrepreneurs do not invest on themselves they want to be a great but they do not read
nor research.

POOR LOCATION

 This cause is happens in business failure due to poor location area or settlement of business
firms.

LACUS OF FOCUS

 A good entrepreneur or business person will never lose focus on what important & where the
priorities are.

WRONG EXPECTATIONS

 Same start ups were being sold the ideas that all they need to do is get into business & the
money start s rolling in without doing any things.

QUIT TING TOO SOON

 This is the biggest reason why many business fail

MAJOR FORMAL& INFORMAL MEANS OF SOVLING FINACIAL DISTRIES

We can defines the two term in different ways

In case of informal organization in the interlocking social structure that governs how people work to
gather in practice it is the aggregate of norms personal & professional connection through which
work gets done & relationships are built among people who share a common organization
affiliation or cluster of affiliation it consists of dynamic set of personal relationships social network
s communities of common interest in emotional sources of motivation

In general of resolving financial distress are conceivable either by creditors privatively.

Bankruptcy prediction is the art of predicting bankruptcy and various measures of financial
distress of public firms. It is a vast area of finance and accounting research. The importance of
the area is due in part to the relevance for creditors and investors in evaluating the likelihood that
a firm may go bankrupt.
Chapter 11

This is the most common type of corporate bankruptcy for public companies. In a Chapter 11
bankruptcy, a company continues normal day-to-day operations while ratifying a plan to
reorganize its business and assets in such a way that will make it able to meet its financial
obligations and eventually emerge from bankruptcy

Bankruptcy is a word that few people like to hear, but it can present great opportunities for investors
willing to do a little hands-on research. Bankruptcy is a process that occurs when a company can no
longer afford to make payments on their debt. Often, this comes as a result of a bad economic
environment, poor internal management, over-expansion, new liabilities, new regulations and a host of
other reasons.

The quantity of research is also a function of the availability of data: for public firms which went
bankrupt or did not, numerous accounting ratios that might indicate danger can be calculated,
and numerous other potential explanatory variables are also available. Consequently, the area is
well-suited for testing of increasingly sophisticated, data-intensive forecasting approaches.

Bankruptcy is the legal proceeding involving a person or business that is unable to repay
outstanding debts. The bankruptcy process begins with a petition filed by the debtor, which is
most common, or on behalf of creditors, which is less common. All of the debtor's assets are
measured and evaluated, and the assets may be used to repay a portion of outstanding debt.

Bankruptcy offers an individual or business a chance to start fresh by forgiving debts that simply
cannot be paid while offering creditors a chance to obtain some measure of repayment based on
the individual's or business's assets available for liquidation. In theory, the ability to file for
bankruptcy can benefit an overall economy by giving persons and businesses a second chance to
gain access to consumer credit and by providing creditors with a measure of debt repayment.
Upon the successful completion of bankruptcy proceedings, the debtor is relieved of the debt
obligations incurred prior to filing for bankruptcy.

All bankruptcy cases in the United States are handled through federal courts. Any decisions over
federal bankruptcy cases are made by a bankruptcy judge, including whether a debtor is eligible
to file or whether he should be discharged of his debts. Administration over bankruptcy cases is
often handled by a trustee, an officer appointed by the United States Trustee Program of the
Department of Justice, to represent the debtor's estate in the proceeding. There is usually very
little direct contact between the debtor and the judge unless there is some objection made in the
case by a creditor.

a. What is a prepackaged bankruptcy?

A prepackaged bankruptcy is a plan for financial reorganization that a company prepares in

cooperation with its creditors that will take effect once the company enters Chapter 11. This plan
must be voted on by shareholders before the company files its petition for bankruptcy, and can
result in shorter turnaround times.
Prepackaged bankruptcy refers to a plan for reorganization under Chapter 11 that a company
drafts in cooperation with its lenders.

Key Takeaways

 A prepackaged bankruptcy is a corporate strategy to emerge from bankruptcy by negotiating

with its creditors in advance of Chapter 11 proceedings.
 The goal of such a plan, which must be approved by shareholders, is to speed up the overall
time that company is under bankruptcy protection.
 Some creditors, however, may take advantage of being forewarned of an imminent bankruptcy
and become uncooperative, undermining the goal of being prepackaged.

How Prepackaged Bankruptcy Works

The idea behind a prepackaged bankruptcy plan is to shorten and simplify the bankruptcy
process in order to save the company money in legal and accounting fees, as well as the amount
of time spent in bankruptcy protection. A proactive company in distress will notify its creditors
that wish to negotiate terms of bankruptcy before it files for protection in court.

If a company determines that Chapter 11 bankruptcy is inevitable, it may first contact and meet
with its lenders in order to formulate a mutually beneficial reorganization plan prior to any
official proceedings. The prepackaged bankruptcy is submitted to the bankruptcy court at the
same time the company files its official bankruptcy petition, and the court then decides whether
or not to accept the proposed plan.

These creditors—lenders, inventory suppliers, service providers—naturally do not like the

distressed situation of the company, but will work with it to minimize time and expenses
associated with bankruptcy reorganizations.

The creditors are more apt to be amenable during the negotiations to rework terms since they will
have a voice before the bankruptcy filing; the alternative would be a surprise and then a scramble
to deal with the delinquent debtor with more uncertainty about how long the process will take.

A company and its creditors can expect a resolution within a much shorter time frame under a
prepackaged bankruptcy than a conventional one. Three to nine months is typical. The sooner the
company can emerge from bankruptcy, the sooner it can implement its reorganization in an
attempt to return to healthy business operations.

Pros and Cons of a Prepackaged Bankruptcy

As mentioned above, the advantages include saving expenses and time. The process of entering
and exiting Chapter 11 is smoother, with creditors on board with a reorganization plan
beforehand. In addition, the company can avoid some of the negative publicity that results from a
longer drawn-out bankruptcy process involving creditors fighting for their claims.
A prepackaged bankruptcy does have a major risk, however. If a creditor knows that a
bankruptcy filing is imminent, it may take an aggressive stance in collecting from the company
before the Chapter 11 filing. This may upset the intended cooperative nature of prepackaged
bankruptcy negotiations. Others may follow suit, causing more financial stress on the company

How Reorganization and Liquidation can apply during Bankruptcy?

Entry and exit are fundamental underpinnings of the competitive process. They ensure that a sufficient
number of firms remain in an industry, and produce efficiently, in order to satisfy the market demand at
a competitive price. Moreover, entry and exit need not be in the form of firms actually appearing on, or
departing from, the industry scene. They may well be in the form of an increase or a reduction in the
volume of activities and the volume of resources engaged in the production process, or a change in the
type of activity. The competitive process results in the flow of resources into efficient units and out of
inefficient ones - a process which may also be interpreted as 'entry' and 'exit'. A contraction of demand
for some products, for example, should lead to either the exit of resources from some of the production
units, or the closure of some plants, in an industry. With modern large scale corporations the exit
process is, most often, characterized by a reorganization of resources- their withdrawal from some, and
flow into other, activities. In this sense market economies can be characterized by an almost permanent
flow of resources out of old, inefficient activities and into new ones. Only in a small number of cases,
and generally rarely, is the exit of resources associated with financial distress, default on debt,
insolvency and ultimately bankruptcy and the disappearance of the firm. Modern firms are
characterized by a web of formal and implicit contracts which integrate and articulate the interests of
different parties with claims on a firm’s assets. The interested parties, or claimants, include the firm’s
creditors with varying degrees of seniority: government, banks or creditors with secured collateral,
employees, ordinary bondholders and unsecured creditors, customers, suppliers and, of course,
managers and shareholders. These formal and implicit contracts are part and parcel of the system of
property rights in developed market economies. Their operation is facilitated through the financial
system and financial markets. The financial institutions and markets provide information on the
performance of various economic units and agents (search light effect), invoke appropriate reactions
from the market participants, and impose certain disciplines on those units and agents. When, in an
economy with developed financial markets, firms get into financial difficulty, the distress will manifest
itself in lower share prices, and will set in motion a number of possible mechanisms. On the one hand,
mergers and take-overs may be encouraged (or provoked) by the appearance of signs of financial
distress and lower share prices. This is particularly the case if other market participants consider the
firm's