Financial Management of Sick Units : Financial Management of Sick Units By:
Dr S O Junare Slide 2: The financial management of sick units is divided into six sections
Definition of sickness
Causes of sickness
Symptoms of sickness
Prediction of sickness
Revival of a sick unit
Turnaround stories DEFINITION OF SICKNESS : DEFINITION OF SICKNESS RBI defined a sick unit as “One which has incurred cash losses fore one year and, in the judgment of the financing bank, is likely to incur cash losses for the current as well as following year and/or there is an imbalance in the unit’s financial structure, that is, current ratio is less then 1:1 and debt/equity ratio is worsening.” Slide 4: Term lending financial institutions classify a unit as sick after considering any of the following symptoms:
Default in meeting four consecutive half-yearly installments of interest or principal in respect of institutional loans.
Cash losses for a period of two years or continued erosion in net worth, say by 50 percent.
Mounting arrears on account of statutory and other liabilities for a period of 1 to 2 years. Slide 5: Broader definition:
An industrial unit may be regarded as sick if …
It faces financial embarrassment (arising out of its inability to honour its obligations as and they matured), and
Its viability is seriously threatened by adverse factors. CAUSES OF SICKNESS : CAUSES OF SICKNESS Unfavorable external environment
Personal Unfavorable External Environment : Unfavorable External Environment Shortage of key inputs
Changes in government policies
Development of new technologies
Sudden decline in orders from major customer
Shifts in consumer preferences
Natural calamities Managerial Deficiencies : Managerial Deficiencies Production
Uneconomic plant size
Poor maintenance Slide 9: Marketing
Inaccurate demand projection
Improper product mix
High distribution cost
Poor customer service Slide 10: Finance
Wrong capital structure
Bad investment decisions
Weak budgetary control
Improper tax planning Slide 11: Personnel
Bad labor relations
Weak employee commitment SYMPTOMS OF SICKNESS : SYMPTOMS OF SICKNESS Delay or default in payment to suppliers
Irregularity in the bank account
Decline in capacity utilization
Low turnover of assets
Accumulation of inventories
Excessive turnover of personnel
Extension of accounting period
Poor maintenance of plant and machinery
Decline in the price of equity shares and debentures Prediction of Sickness : Prediction of Sickness Univariate Analysis
Multivariate Analysis Univariate Analysis : Univariate Analysis In Univariate analysis, an attempt is made to predict sickness on the basis of single financial ratio.
Beaver conducted three types of analysis to determine the predictive power of financial ratios:
A comparison of mean values
A dichotomous classification analysis, and
An analysis for likelihood ratios Multivariate Analysis : Multivariate Analysis Multivariate technique, commonly used in predicting business failure or sickness, is the technique of multiple discriminant analysis. This is a statistical technique which helps in classifying an observation into one of the several pre-specified groups on the basis of certain characteristics of the observation. It essentially involves estimating a function which discriminates best between the groups. The discriminant function is usually a linear one. A Critique of Bankruptcy Prediction Models : A Critique of Bankruptcy Prediction Models Though various bankruptcy prediction models appear to posses some predictive value, it is very difficult to generalise about corporate failure for the following reasons:-
We do not have a well-defined theory of corporate failure to guide empirical work. In the absence of such a theory, empirical research involves a great deal of experimentation with different variables.
Empirical studies are statistically flawed because they are retrospective in nature. Revival of Sick Unit : Revival of Sick Unit When an industrial unit is identified as sick, a viability study should be conducted to assess whether the unit can be revived/rehabilitated within a reasonable period. If viability study suggests that the unit can be rehabilitated, a suitable plan for rehabilitation must be formulated. If the viability study indicates that the unit is “better dead than alive”, steps must be taken to liquidate it expeditiously. Viability Study : Viability Study A reasonably comprehensive assessment of the various aspects of the working of a unit, a viability study generally covers the following:
Environment Market Analysis : Market Analysis Market share behaviour over the past few years.
Growth rate of the total market.
Emergence of competition.
Comparative price and cost analysis.
Order book position.
Unique selling proposition, if any, employed by the firm.
Consumer attitudes, preference, and needs.
Promotional strategies of the firm and its consumers.
Distribution channels used by the firm.
Distributor cost analysis. Production/Technical Analysis : Production/Technical Analysis Technological capability of the firm.
Degree of balance in the capacities at different stages of manufacturing.
Plant maintenance system.
Availability of power, water, fuel, and other utilities.
Supply of raw materials. Finance : Finance Liquidity position.
Turnover of assets.
Estimate of working capital needs.
Balance sheet and income statement projection.
Budgetary control and responsibility accounting.
Cost control and reduction. Personnel Organisation : Personnel Organisation Human resources.
Employee motivation, morale, and commitment.
Manpower in relation to needs. Environment : Environment Supply of raw material.
Availability of power, fuel, and water.
Governmental policies with respect to excise duties, custom duties, export duties, reservations, etc.
Industrial licensing policy.
Lending policies of financial institutions and commercial banks.
General industrial relations situation.
Competitive developments. Results of viability study : Results of viability study The viability study may suggest on of the following:
The unit can be revived by adopting one or more of the following measures:
Debt restructuring, infusion of funds, correction of functional deficiencies, granting of special reliefs and concessions by the government, replacement of existing management because of its incompetence and/or dishonesty.
The unit is not potentially viable- this essentially implies that the benefits expected from remedial measures are less than the cost of such remedial measures Revival Programme : Revival Programme Settlement with creditors
Provision of additional capital
Divestment and disposal
Reformulation of product-market strategy
Modernisation of plant and machinery
Reduction in manpower
Strict control over costs
Streamlining of operations
Improvement in managerial systems
Change of management
Debt restructuring THANK YOU : THANK YOU