What key issues must managers face in the financial distress process?

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What key issues must managers face in the financial distress process?

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Kimberly MacKenzie—president of Kim’s Clothes Inc., a medium-sized manufacturer of women’s casual clothing—is worried. Her firm has been selling clothes to Russ Brothers Department Store for more than 10 years, and she has never experienced any problems in collecting payment for the merchandise sold. Currently, Russ Brothers owes Kim’s Clothes $65,000 for spring sportswear that was delivered to the store just 2 weeks ago. Kim’s concern arose from reading an article in yesterday’s Wall Street Journal that indicated Russ Brothers was having serious financial problems. Moreover, the article stated that Russ Brothers’ management was considering filing for reorganization, or even liquidation, with a federal bankruptcy court.
 
Kim’s immediate concern is whether her firm will collect its receivables if Russ Brothers goes bankrupt. In pondering the situation, Kim has also realized that she knows nothing about the process that firms go through when they encounter severe financial distress. To learn more about bankruptcy, reorganization, and liquidation, Kim has asked Ron Mitchell, her firm’s chief financial officer, to prepare a briefing on the subject for the entire board of directors. In turn, Ron has asked you, a newly hired financial analyst, to do the groundwork for the briefing by answering the following questions:
 
What key issues must managers face in the financial distress process?

Explanation & AnswerSolution by a verified expert

Explanation

Following are the five issues that arise when a firm is in financial distress-

Is the inability of debt payment a temporary cash-flow problem or a permanent problem? A permanent problem may be caused by a decline in asset values below debt obligations.
If it is a temporary problem, the company may agree with the creditors to recover its financial health. If there is a long-term loss where asset values have declined and economic losses have occurred, then the parties bearing the losses and parties receiving their claims must be decided.
The company's worth in selling off its assets and in continued operations must be estimated. If the company is worth more by selling its assets than its continued operations, then the company should cease to exist and use the proceeds from sale of assets to pay off its debt obligations.
Should the company use informal liquidation procedures or reorganization or file for protection under chapter 11 of the bankruptcy law?
Who should control the firm during liquidation or reorganization? Should a trustee be hired, or existing management left in charge of the procedures?

Verified Answer

Following are the five issues that arise when a firm is in financial distress-

 Is the inability of debt payment a temporary or a permanent problem?
If it is a temporary problem, the company may agree with the creditors to recover its financial health. If there is a long-term loss, then the parties bearing the loss must be decided.
Company's worth in selling off its assets and in continued operations must be estimated.
The mode of liquidation or reorganisation must be decided.
Who should handle the process of liquidation or reorganisation?

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