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Corporate Financial Distress: Internal and External Causes and Solutions to Avoid It

Many companies face a serious problem that may threaten their continuity in the market, which is the problem of financial distressMany companies face a serious problem that could threaten their continued success in the market: financial distress. Financial distress refers to a company's inability to meet its obligations or debts on time, also known as debt management failure. This crisis can occur suddenly, and management may not realize its causes until it's too late. In this article, we review […]

In this article, we review the internal and external causes of financial distress, then offer the best solutions to avoid it.

First: Internal causes of financial distress

Internal reasons are those that are directly related to the company's management and its decisions:

  1. Neglecting operational and financial plans developed at the beginning of operation or the beginning of the year.
  2. Operational disruption due to management not taking obstacles and problems seriously.
  3. Crises worsen as profits and cash flows decline, and companies resort to long-term borrowing or asset sales to repay liabilities.
  4. Accumulating losses and a lack of liquidity until the company reaches a stage of actual default, which may end in declaring bankruptcy and liquidating the business.

Results of internal mismanagement

  • Low productivity and high labor turnover.
  • Increased waste of raw materials or finished products.
  • Frequent breakdowns in production lines.
  • High operating and production costs.
  • Declining profits and loss of competitiveness.

Root causes

  • Lack of budget estimate for the work from the beginning.
  • Not conducting feasibility studies for new projects.
  • Over-reliance on borrowing and increased interest costs.
  • Ignoring real financial indicators when making decisions.

Second: Internal causes of financial distress

Even with good management, companies may face external factors beyond their control, such as:

  1. Economic depression as it happened during the Corona pandemic.
  2. Interest rates rise, raising borrowing costs.
  3. Decrease in the value of the currency due to inflation.
  4. Market instability and associated fluctuations affect sales and profits.

Third: Solutions to avoid financial distress

To protect a company from falling into financial distress, several preventive measures are necessary:

  1. Preparing an accurate budget that includes all departments and production processes.
  2. Conducting comprehensive feasibility studies for any new project or production line.
  3. Monitor and analyze financial indicators periodically.
  4. Create a clear cash flow management model.
  5. Dealing with sudden problems quickly and professionally.
  6. Applying the principle of prevention is better than cure through early warning of financial risks.

Conclusion

Financial distress does not occur suddenly; rather, it is the result of an accumulation of internal factors related to mismanagement, or external factors related to market conditions. The solution lies in sound financial planning, continuous monitoring, and a feasibility study before any action. Companies that adhere to these measures will be better able to continue and compete in the market.