44980018 Sick Units Final Ppt

7/28/2019 44980018 Sick Units Final Ppt

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Financial Management of SickUnits

Chapter 12


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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.


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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 thefinancing bank,

is likely to incur cash losses for current as well as forthe following year, and/or there is an imbalance in the

units financial structure, that is,when the ratio of current assets to current liabilities isless than 1:1, and debt equity ratio is worsening


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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 lossesin such financial year and the financial year immediately

preceding such financial year.


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Sick units

Term lending financial institutions classify aunit as sick after considering any of the

following symptoms:

Default in meeting four consecutive half-yearlyinstallments 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.


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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


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UNFAVOURABLE 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.


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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

02. Production/

Technical

Wrong choice of technology Improper utilization of production capacity

Imbalanced and Defective Machinery Poor Raw-material Planning InadequateQuality Control Poor labour relations Location problem

03. Marketing Lack of Market Planning Inadequate Market Survey Poor Collections Defective

Pricing

04. Finance Poor Management of Financial Resources Delay in Mobilisation of Equity Funds

Faulty Costing Adverse debt-equity combination Lack of Proper Accountingsystem

05. Personnel Lack of Competence Lack of Loyalty Lack of Professionalism

Managerial Deficiencies


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SOME OF THE FACTS OF SICKNESS

Internal facts

Marketing problem (31%)

Management inefficiency andlack of entrepreneurial skills

(22%) Faulty project planning and

appraisal (14%)

Imbalance of machinery andinappropriate technology (12%)

Implementation delay in

(mobilization of equity, etc.)(12%)

Others (diversion of funds,labor problem, etc.) (9%)

External facts

Delays in loan sanction anddisbursement (22%)

Non- availability/ shortage of

working capital (21%) Power problem (15%)

Changes in Govt. policy(import liberalization) (13%)

Non-availability/ irregularsupply of raw material and

other critical inputs (11%)

Natural calamities (57%)

Smuggling, Political unrest (5%)

Others (8%)


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PREDICTION OF SICKNESS

The Financial ratios can be predicting industrialsickness with greater reliability in which there are two

types of analysis:

Univariate Analysis.

Multivariate Analysis.


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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


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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 thebasis 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.


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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.


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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 betterdead than

alive, steps must be taken to liquidate it expeditiously.


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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.


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03. Personnel

Organisation.

Human resources.

Employee motivation, morale, and commitment. Leadership.

Manpower in relation to needs.

04. 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.

05. 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.

Viability Study


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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 followingmeasures:

Debt restructuring, infusion of funds, correction of functionaldeficiencies, granting of special reliefs and concessions by thegovernment, replacement of existing management because ofits incompetence and/or dishonesty.

The unit is not potentially viable- this essentially implies thatthe benefits expected from remedial measures are less than thecost of such remedial measures


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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 managerialsystems.

Workers participation.

Change of management.

Debt restructuring.


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TURNAROUND STORIES

TVS Suzuki

Started in 1987

Was a profit making company

But, incurred losses in 1989-90 & 1990-91


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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.


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Learning Outcomes

The sick units may be attempted to be turned

around through efficient management,

change of top level executive,

executing a turnaround strategy.

Documents

44980018 Sick Units Final Ppt