Distress Cost

AAA

DEFINITION of 'Distress Cost'

Costs that a firm in financial distress faces beyond the cost of doing business. Distress costs are broken down into two categories: ex ante (before the event) and ex post (after the event), with the event in this case being a bankruptcy. Ex ante distress costs include increased borrowing costs, since lenders will charge higher rates to firms in financial trouble. Ex post distress costs include the cost of filing for bankruptcy, hiring lawyers and accountants to work on bankruptcy proceedings, and other administrative costs associated with closing out a business. 

INVESTOPEDIA EXPLAINS 'Distress Cost'

Firms with rising distress costs not only face potential bankruptcy, but also a loss of profitability as management becomes preoccupied with the threat of bankruptcy, employees show lower productivity as they worry about their jobs, suppliers charge more money up front for goods and services rather than allowing future invoicing, and customers search for healthier companies to do business with. In this sense, distress costs can lead to a vicious cycle.

Analysts reviewing a company’s financials in order to assign a value typically assume that the business will be around for the foreseeable future, and that any financial distress is temporary in nature. These assumptions allow the valuation to include a discounted cash flow from relatively far into the future.

However, if the company faces financial problems that are not temporary, this can affect the company’s terminal value. Because non-temporary financial distress is less common, it can be hard for analysts to valuate a company, since it’s significantly more difficult to understand how distress will impact future cash flows.

RELATED TERMS
  1. Involuntary Bankruptcy

    A legal proceeding in which a person or business is requested ...
  2. Distress Termination

    A thinning of an employee base that takes place when a company's ...
  3. Voluntary Bankruptcy

    A type of bankruptcy where an insolvent debtor brings the petition ...
  4. Distressed Borrower

    A borrower who is unable to fully repay his or her debt due to ...
  5. Financial Distress

    A condition where a company cannot meet or has difficulty paying ...
  6. Bankruptcy Trustee

    A person appointed by the United States Trustee, an officer of ...
Related Articles
  1. How To Survive A Bankruptcy Filing
    Credit & Loans

    How To Survive A Bankruptcy Filing

  2. Does a shareholder lose all of their ...
    Investing

    Does a shareholder lose all of their ...

  3. What are the differences between chapter ...
    Entrepreneurship

    What are the differences between chapter ...

  4. Is tracking error a significant measure ...
    Trading Strategies

    Is tracking error a significant measure ...

Hot Definitions
  1. Debit Spread

    Two options with different market prices that an investor trades on the same underlying security. The higher priced option ...
  2. Leading Indicator

    A measurable economic factor that changes before the economy starts to follow a particular pattern or trend. Leading indicators ...
  3. Wage-Price Spiral

    A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. ...
  4. Accelerated Depreciation

    Any method of depreciation used for accounting or income tax purposes that allows greater deductions in the earlier years ...
  5. Call Risk

    The risk, faced by a holder of a callable bond, that a bond issuer will take advantage of the callable bond feature and redeem ...
  6. Parity Price

    When the price of an asset is directly linked to another price. Examples of parity price are: 1. Convertibles - the price ...
Trading Center