Is financial distress risk important for manufacturing SMEs to rebalance the short-term debt ratio?

Purpose - This study seeks to analyse if the adjustment towards the target short-term debt ratio of small and medium-sized firms (SMEs) is related to financial distress risk. Design/methodology/approach - Data obtained for a sample of Portuguese manufacturing SMEs from 2010 to 2017 were analysed using the system-generalised method of moments (GMM-sys). Using the modifiedZ-Altman score, the authors classify SMEs according to their exposure to financial distress risk. Findings - Manufacturing SMEs exposed to a high risk of financial distress rebalance their short-term debt ratio quicker. However, regardless of the financial distress risk level, SMEs distant from the target short-term debt ratio adjust more slowly, suggesting that transaction costs are greater than financial distress costs. Practical implications - Policymakers should promote the access to external sources of finance with low transaction costs for SMEs, exposed to low levels of financial distress risk, to rebalance their short-term debt ratios quicker. Distressed SMEs far from their target short-term debt ratios, but with capacity to rebalance, need government programmes to access finance with low transaction costs to rebalance their short-term debt ratios. Originality/value - This paper contributes to deepening our understanding of how SMEs, facing financial risk, rebalance their short-term debt ratios. SMEs, facing high financial distress risk, adjust towards their target short-term debt ratios more rapidly. However, SMEs, distant from the target short-term debt ratio face higher transaction costs than financial distress costs. These firms adjust towards their target short-term debt ratios more slowly, which may aggravate the refinancing risk and, ultimately, announce bankruptcy.