Impact Size and Determinants of Indirect Cost of Financial Distress: Role of Receivable and Inventory Management

Umar Farooq (), Muhammad Ali Jibran Qamar and Krishna Reddy
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Umar Farooq: FAST School of Management, National University of Computer and Emerging Sciences, Loonaywala Stop, Faisalabad-Chiniot Road, Faisalabad, Pakistan
Muhammad Ali Jibran Qamar: Department of Management Sciences, COMSATS University Islamabad, Lahore, Pakistan
Krishna Reddy: Waikato School of Accounting Economics and Finance, University of Waikato, Hillcrest, Hamilton 3216, New Zealand

Asian Academy of Management Journal of Accounting and Finance (AAMJAF), 2020, vol. 16, issue 2, 179-207

Abstract: This research investigates the opportunity cost as an indirect cost of financial distress from two perspectives. First, indirect cost is estimated using multi-stage financial distress and non-linear proxy of debt. Second, receivable and inventory management are studied as determinants of indirect cost. The sample includes ongoing Pakistani firms that were healthy in the previous year and documenting positive gross profit. Results showed that firms bear opportunity loss primarily due to leverage rather than multistage financial distress. However, a non-linear relationship is found between leverage and indirect cost. Results further explored the impact of multistage financial distress on internal operations, i.e., working capital policies. It is found that firms manage receivable and inventory simultaneously during the multistage financial distress. Results revealed that increasing receivables and decreasing inventory is suitable during the transition of healthy firms to initial stage of financial distress, i.e., profit reduction. However, decreasing receivables, along with holding more inventory, is recommended for healthy firms that face liquidity problems subsequently. It is concluded that managers can reduce the indirect cost after deploying the optimal debt ratio and recommended receivable and inventory management policies.

Keywords: opportunity loss; financial distress; capital structure; receivable; inventory; Pakistan; developing countries (search for similar items in EconPapers)
Date: 2020
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