Advances in Economics, Business and Management Research, volume 56 3rd International Conference on Economic and Business Management (FEBM 2018) The Analysis of Causes of Business Financial Distress Lucia Michalkovaa*, Peter Adamkob, Maria Kovacovac Faculty of Operation and Economics of Transport and Communications University of Zilina Zilina, the Slovak Republic [email protected] a* [email protected] b [email protected] c Abstract—Economic growth is one of the most striking difficulties resulting in a failure to meet financial obligations phenomena of recent years. The global economy is considered to within their payment terms and to their full extent. There are be powerful and powerful. Nevertheless, signs of the currently a few hundreds, perhaps up to thousands of prediction deteriorating financial condition of the state, the population and models that have been developed at a specific time and under surrounding businesses must be perceived. Financial the conditions of specific economies [6-8]. The basic question management of any company should not neglect examining the that their authors had to ask is: when can we consider the causes of financial distress from a microeconomic and business "financially sound" and when it is on the way to macroeconomic perspective. At the same time, businesses do not failure or bankruptcy. In order to be able to answer this look at these causes as separate events, but perceive their question with justification, we should first know the causes of interconnectedness. The aim of this paper is therefore to detect, the failure. A wide range of causes exists, we will list some of investigate and summarize the causes of corporate failure. them. I.I. Mitroff [9] discovers eight basic causes of financial Keywords—Deterioration of financial health; Bankrupcy; health deterioration: Prediction model; Corporate failure Economic causes - strikes, labor riots, market failure, a decline in core earnings and sharp changes in market I. INTRODUCTION prices. The 2009 financial crisis has brought failures and Information causes - incorrect information, loss of subsequent bankruptcy to many businesses not excluding protected and confidential information, machinations investment bank Lehman Brothers. Both the lay public and with computer data processing, loss of sensitive data many economists consider this moment as the beginning of one related to customers, suppliers and other stakeholders. of the biggest crises of since the Great Depression in the 1930s. Physical causes - loss, destruction or damage to However, the Lehman Brothers bankruptcy must be considered important assets - raw materials, machinery and as a consequence or a symptom of the crisis and not its cause. equipment, means of transport. The causes of the financial crisis can be a policy of cheap Human resources - departure, loss of key experts or money (low interest rates, cheap mortgage loans) that is linked managers, lack of skilled workforce in the labor market. to the unbearable debt of the state, the population as well as the Reputation - defamation, spreading false or alarming enterprises [1-3]. news about the company, damaging the good name of the business, theft of intellectual property, imitation of Businesses should reflect changes in macroeconomic business logo. indicators, the state's economic situation and global economic Causes of criminal nature - hostile takeover, terrorism, trends. Adequate evaluation of these phenomena can provide violence at the workplace. the company sufficient time and financial reserves to overcome Natural disasters - earthquakes, fires, floods, hurricanes, the global crisis [4.5]. On the other hand, the immediate whirlwinds, volcano eruptions, etc. vicinity of the business should not be neglected either. The causes of the crisis may not be macroeconomic in nature; on Slatter & Lovett [10] divide the causes of business financial the contrary, they may be based on a lack of financial health deterioration into endogenous and exogenous ones, and management, bad relations with business partners, and so on. they explore these causes further in detail. They further state that exogenous factors can only affect companies in a minimal The aim of this paper is therefore to detect, investigate and way but the company cannot be separated from the current summarize the causes of corporate failure. dynamically evolving environment. 1. Endogenous causes II. CAUSES OF BUSINESSES FINANCIAL HEALTH DETERIORATION weak management and its mistakes, In general, the term "financial distress" is used in a negative insufficient financial control, connotation to describe the financial health of an enterprise that is confronted with a temporary liquidity shortage and with poor management of working capital, Copyright © 2018, the Authors. Published by Atlantis Press. This is an open access article under the CC BY-NC license (http://creativecommons.org/licenses/by-nc/4.0/). 49 Advances in Economics, Business and Management Research, volume 56 high expenses, government policies in this area as the cause of the insufficient marketing, deterioration of business financial health. However, he adds undertaking projects which are too large for the that under the same circumstances, some businesses will company, survive while others will be failing. Authors Charan and excessive production volume compared to the structure Useem [14] claim that the main causes of business failure are: of financing, acts of God, negative impacts of mergers and acquisitions, managerial errors, inappropriate financial policy of the company, relaxation (blessing) because of achieved success, incorrect and ambiguous in-house policies that lead to behavior of competitors, the lack of commitment and confusion between underestimation of negative messages and trends, employees during their fulfillment. acceptance of excessively high risk. 2. Exogenous causes Another important issue that needs to be taken into account negative changes in market demand for the company´s when assessing the financial health of companies is the products, relationship between the age of the firm and the possibility of competition, failure. Dun and Bradstreet, inc. [15] in its research showed change in input commodity prices in an unfavorable that more than 50% of all failures occurred in enterprises direction. "aged" from two to five years. After five years of existence businesses tend to be more stable and experienced, indirect On the basis of general economic theory Lizal [11] defines consequences of that is a better access to capital, whether in the three causes or models that can detect the deterioration of the form of a loan or through issuing shares or bonds. Other, company financial health: especially financial reasons for corporate failure, are as follows: The neoclassical model, in which case bankruptcy is Industry sectors - some industries tend to be chronically considered a positive event because it allows the release "unhealthy". Businesses operating in these sectors have of assets that have not been allocated efficiently. In this a high probability of failure in the near future, case, the market has basically a healing effect as inefficient businesses also consume inputs, which is not Interest rates - As a result of high interest rates, some desirable from the economic point of view because the businesses will find themselves in a situation where assets were allocated for inappropriate business they can no longer repay their obligations to the bank, activities. whether in the form of interest or principal repayments. The financial model which works with the idea that the Competition - international division of labour and assets are correctly allocated, but that the structure of competition enormously increases business spending. asset covering resources was inadequately set, i.e., Debts to equity ratio - Businesses, especially in the weighted average cost of capital (WACC) is not United States, have increased the volume of foreign minimal. In other words, the capital structure is not resources. The financial leverage has increased, but optimal. businesses have become more vulnerable. This fact is The corporate governance model which is based on the particularly important in the economic recession. premise that both the assets and the liabilities of the Deregulation - deregulation of key sectors leads to a company described in the previous two models are used competitive environment, which reduces the value of efficiently, but there is poor management of the monopolistic rent. company, therefore, the bankruptcy is the result of ineffective problem management. Growth rate - high speed of creating new businesses will cause higher business failure rates. New businesses Altman and Hotchkiss [12] mention other causes of are characterized by a higher probability of failure than deterioration in the financial health of enterprises, which most established businesses, as was stated in the introduction of the businesses cannot influence, these are, therefore, external to this paragraph. factors: The causes of financial problems of enterprises are dealt chronically problematic sectors of economy (e.g. with by G. W. Newton [16] who bases his work on both the agriculture, textile industry, etc.) Dun and Bradstreet study, he lists causes of business failure as deregulation of key sectors (e.g. airlines, financial follows: services, healthcare, energy); high real interest rates, inability to manage cash flow, international