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Lecture 11

FINA601 Lecture Notes - Lecture 11: Operating Cash Flow, Financial Distress, Cash Flow


Department
FINA
Course Code
FINA601
Professor
Ivan
Lecture
11

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Week 11 Lecture 11 Chapter 30: Financial Distress
What Is Financial Distress? (30.1)
Financial distress is surprisingly hard to define precisely - The list of events is almost
endless, but here are some examples:
Dividend reductions
Plant closings
Losses
Layoffs
CEO resignations
Plummeting stock prices
Financial distress is a situation where a firm’s operating cash flows are not sufficient to
satisfy current obligations (such as trade credits or interest expenses) and the firm is forced
to take corrective action
Financial distress may lead a firm to default on a contract, and it may involve financial
restructuring between the firm, its creditors, and its equity investors. - Usually the firm is
forced to take actions that it would not have taken if it had sufficient cash flow

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Flow-base Insolvency
Flow-based insolvency occurs when operating cash flow is insufficient to meet
current obligations.
Flow-based insolvency refers to the inability to pay one’s debts. Insolvency may lead
to bankruptcy
Flow-based insolvency occurs when firm cash flows are insufficient to cover
contractually required payments.

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Stock-base Insolvency
Stock-based insolvency occurs when a firm has negative net worth, so the value of
assets is less than the value of its debts.
Stock-based insolvency occurs when the value of the assets of a firm is less than the
value of the debts. This implies negative equity
Stock-base insolvency: the value of the firm’s assets is less than the value of the debt.
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