Financial Management of Sick Units

Chapter 12

Learning Objectives
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 SICK UNITS

According to R.B.I. A unit is considered sick if it has incurred cash losses for one year, and, in the judgment of the financing bank, is likely to incur cash losses for current as well as for the following year, and/or there is an imbalance in the units financial structure, that is, when the ratio of current assets to current liabilities is less than 1:1, and debt equity ratio is worsening

DEFINITION
According to SICA, 1985 A unit was defined as industrial company being a company registered for not less than seven years which has at the end of any financial year accumulated losses equal to or exceeding its entire net worth and has also suffered cash losses in such financial year and the financial year immediately preceding such financial year.

Sick units
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 per cent. Mounting arrears on account of statutory and other liabilities for a period of 1 to 2 years.

CAUSES OF SICKNESS
When favourable environment and efficient management is not in a proper condition the firm is likely to become sick. Hence sickness may be caused by: Unfavourable external environment Managerial deficiencies

UNFAVOURABLE EXTERNAL ENVIRONMENT

Shortage of key inputs. Changes in government policies. Development of new technologies. Sudden decline in orders from customer. Shifts in consumer preferences. Natural calamities.

major

Managerial Deficiencies
Sl. # Broad Area Detail Causes 01. Management Lack of proper education, training, experience and business outlook of the Sponsors/Entrepreneurs Poor Entrepreneurial skills Poor Management Poor Equity base Lack of Integrity/Division of Funds Faulty Project Planning and Appraisal Production/ Technical Wrong choice of technology Improper utilization of production capacity Imbalanced and Defective Machinery Poor Raw-material Planning Inadequate Quality Control Poor labour relations Location problem Lack of Market Planning Inadequate Market Survey Poor Collections Defective Pricing Poor Management of Financial Resources Delay in Mobilisation of Equity Funds Faulty Costing Adverse debt-equity combination Lack of Proper Accounting system Lack of Competence Lack of Loyalty Lack of Professionalism

02.

03.

Marketing

04.

Finance

05.

Personnel

SOME OF THE FACTS OF SICKNESS

Internal facts
Marketing problem (31%) Management inefficiency and lack of entrepreneurial skills (22%) Faulty project planning and appraisal (14%) Imbalance of machinery and inappropriate technology (12%) Implementation delay in (mobilization of equity, etc.) (12%) Others (diversion of funds, labor problem, etc.) (9%)

External facts
Delays in loan sanction and disbursement (22%) Non- availability/ shortage of working capital (21%) Power problem (15%) Changes in Govt. policy (import liberalization) (13%) Non-availability/ irregular supply of raw material and other critical inputs (11%) Natural calamities (57%) Smuggling, Political unrest (5%) Others (8%)

SYMPTOMS OF SICKNESS
Following are the 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
The Financial ratios can be predicting industrial sickness with greater reliability in which there are two types of analysis:

Univariate Analysis. Multivariate 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 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

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

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
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.

Viability Study
Sl. # 01.

Broad Area Production / Technical Analysis.

Detail 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. 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.

Market Analysis.

02.

Viability Study
03.

Human resources. Personnel Organisation. Employee motivation, morale, and commitment. Leadership. Manpower in relation to needs. 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. 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.

04.

05.

Environment.

Finance.

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
Settlement with creditors. Provision of additional capital. Divestment and disposal. Reformulation of productmarket strategy. Modernisation of plant and machinery. Reduction in manpower. Strict control over costs. Streamlining of operations. Improvement in managerial systems. Workers participation. Change of management. Debt restructuring.

TURNAROUND STORIES
TVS Suzuki Started in 1987 Was a profit making company But, incurred losses in 1989-90 & 1990-91

Determined to fight competition and improve performance, the company took a series of steps:-

A six month, week-by-week, cost reduction drive. This resulted in the drop of 30 % in the operation cost. A massive exercise in value engineering. Product improvement strategy. A renewed marketing drive.

Learning Outcomes
The sick units may be attempted to be turned around through efficient management, change of top level executive, executing a turnaround strategy.