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

Author

Listed:
  • 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)

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.

Suggested Citation

  • Umar Farooq & Muhammad Ali Jibran Qamar & Krishna Reddy, 2020. "Impact Size and Determinants of Indirect Cost of Financial Distress: Role of Receivable and Inventory Management," Asian Academy of Management Journal of Accounting and Finance (AAMJAF), Penerbit Universiti Sains Malaysia, vol. 16(2), pages 179-207.
    • Handle: RePEc:usm:journl:aamjaf01602_179-207
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    References listed on IDEAS

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