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See all Premium member Presentation Transcript 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 Managerial deficiencies Production Marketing Finance 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 Improper location Wrong technology 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 Ineffective leadership Bad labor relations Over staffing 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: Market Analysis Production/Technical Analysis Finance Personnel Organisation 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. Plant condition. Degree of balance in the capacities at different stages of manufacturing. Manufacturing process. Plant maintenance system. Availability of power, water, fuel, and other utilities. Supply of raw materials. Finance : Finance Liquidity position. Leverage analysis. Turnover of assets. Profitability. 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. Leadership. 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 Worker’s participation Change of management Debt restructuring THANK YOU : THANK YOU You do not have the permission to view this presentation. In order to view it, please contact the author of the presentation.