Indian corporate restrictions and industrial sickness

 

Corporate Restructuring: Meaning

(a)   Corporate restructuring is defined as the process involved in changing the organization of a business.

(b)  It means a change in the business strategy of an organization resulting in diversification, closing parts of the business etc. to increase its long-term profitability

(c)   implies rearranging the business for increased efficiency and profitability.

(d)  It is a method of changing the organizational structure in order to achieve the strategic goals of the organization or to sharpen the focus on achieving them.

(e)   It can involve making dramatic changes to a business by cutting out or merging departments that often has the effect of displacing staff members.

(f)   It involves a process of consolidation or rearrangement in the organization and business operations aimed at strengthening its financial position so as to achieve its short-term and long-term business objectives in the competitive environment.

(g)  The alterations through corporate restructuring have a significant impact on firm's balance sheet by redeploying assets or by exploiting unused financial capacity.

(h)  The corporate restructuring is a process by which a company can consolidate its business operations and strengthen its position for achieving the desired objectives staying synergetic, slim, competitive and successful.

(i)    The underlying object of corporate restructuring is efficient and competitive business operation by increasing the market share, branch power and synergies.

Reasons for corporate restricting

 

•       Global Competition

Global market concept has necessitated many companies to restructure, because lowest cost producers only can survive in the competitive global markets.

•       Government Regulations

The changed fiscal and government policies like deregulation/decontrol has companies to go for newer markets and customer segments.

•       Information Technology

Revolution in information technology has made it necessary for companies to adopt new changes for improving corporate performance.

•       Wrong Segmentation

Many companies have divisionalized into smaller businesses, Wrong divisionalization strategy has led to revamp themselves. Product divisions which do not fit into the company's main line of business are being divested. Fierce competition is forcing the companies to relaunch themselves.

•       Strengths & Weaknesses

The identification of strengths and weaknesses of the company is needed in order to bring focus of the attention of top management to essential needs of the company.

•       Focus on Core Strengths

It needs to focus on core strengths, operational synergy and efficient allocation of managerial capabilities and infrastructure.

•       Cost Reduction

Improved productivity and cost reduction has necessitated downsizing of the work both works and at managerial level.

•       Rupee Convertibility

The convertibility of a rupee has attracted medium-sized companies to operate in the global markets, which requires reorganization of the firm to meet global competition.

•       Core Business

The competitive business necessitated to have sharp focus on core business activities, to gain synergy benefits, to minimize the operating costs, to maximize efficiency in operation and to tap the managerial skills to best advantage of the firm.

•       Economies of Scale

The consolidation of economies of scale by expansion and diversion to extended domestic and global markets.

•       Revival of sick units

The Revival and rehabilitation of a sick unit by adjusting losses of the sick unit with profits exploit of a healthy company. By restructuring the enterprise, a sick company can be successfully revived and rehabilitated, and can be brought back to profitable lines.

•       Material and Technology

The acquiring constant supply of raw materials and access to scientific research and technological developments.

 

•       Capital Restriction

The Capital restructuring by appropriate mix of loan and equity funds to reduce the cost of servicing and improve return on capital employed.

•       Risk Minimization

By diversification of business activities, the minimization of business risks is possible and it will enable the firm to achieve atleast the minimum target rate of return.

•       Strategic tax Planning

With the integration of sick unit into the successful unit, the adjustment of unabsorbed depreciation and write-off of accumulated loss is possible, there by the successful unit can have strategic tax planning.

•       Cost of Capital

Corporate restructuring includes financial reorganization, by bring the company to achieve a desired balance of debt and equity, thereby reduce the overall cost of capital and financial risks.

•       Competition

The restructuring process will facilitate to have horizontal and vertical integration, thereby the competition is eliminated and the company can have access to regular raw materials and reaching new markets and accessibility to scientific research and technological developments.

•       Responsibility Accounting

The application of Information technology and responsibility accounting concepts will facilitate to divide the total enterprise into strategic business units, a better way of achieving the corporate goals.

•       Resource Utilization

It ensures optimum utilization of all resources such that profit centres and drain centres are segregated so as to improve the efficiency and eliminate the losses and leakages.

•       Business Re-engineering

It facilitates re-engineer the manufacturing, industrial and commercial operations in such a way that the cost of capital deployed for each of those operations studied, quantified and reduced.

 

Financial Restructuring: Meaning

 

(a)   It is also referred to as financial reorganization'.

(b)  It can be affected by making change in the capital structure of a company for achieving a balanced operative result.

(c)   Financial restructuring involves restructuring of assets and liabilities of the company. in line with their cash flow needs, in order to promote efficiency, support growth and maximize value to shareholders, creditors and other stakeholders.

(d)  It involves restructuring the assets and liabilities, debt/equity mix, ideal allocation of funds to balance short-term and long-term requirements etc. for achieving efficiency, growth and values to shareholders, creditors and all other stakeholders.

(e)   It is resorted to

1.     bring balance in debt and equity funds

2.     bring balance in short-term and long-term financing

3.     achieve reduction in finance charges

4.     reduce cost of capital

5.     increase EPS

6.     improve market value of share

7.     reduce the control of financiers on the management of the company etc.

(f)   It will bring in change in capital structure, which depends on the following factors

1.     Management control

2.     Cost of different sources of capital

3.     Flotation cost

4.     Cost of servicing the equity and debt

5.     Risk and return profile of the industry

6.     Financial risks involved in debt financing

7.     Flexibility in capital structure

8.     Legal formalities etc.

 

Steps in Financial Restructuring

•       valuation of Business

 

The valuation of business is carried out taking into account the current business situation, prospective growth of business and its earning power. The valuation of a company is done to implement the scheme of financial reorganization. The valuation of company should be based on 'going concern' concept and should not be viewed from the angle of liquidation.

•       Formulation of New Capital Structure

 

The reduction in total debt is brought by reducing of fixed charges burden by bringing in the fresh equity or preference share capital. When the equity is more, the cost of servicing the equity is also highest, can be reduced by relying on debt whenever further position improves the company to strengthen its financial position from unbalanced capital structure.

•       Exchange of Old securities for new securities.

 

The old securities are valued its worth and are exchanged for new securities with new obligations and rights and setup different combinations of ordinary and preference shares, debentures and loan stock to recompensate various interests in the former business. Creditors may take shares in settlement of their claims. Sometimes, fresh shares may also be issued to mobilize funds for reorganized business situation.

COMPANIES ACT 2013 DEFINITION OF INDUSTRIAL SICKNESS: MEANING

 

Sick companies

 

Sections 253(1) of the Companies act 2013 define sickness as when on demand by the secured creditors of a company representing the 50% or more of its outstanding amount of debt and the company has failed to satisfy the secured creditor within 30days of the demand notice. In such instance any of the Creditor, may file an application before the Tribunal that company may be declared as a sick company. The application shall be submitted with documentary evidences for example any agreement of loan, demand notice, account statements etc. The tribunal herein abovementioned is National Company Law Tribunal as defined in the section 2(90) of the Companies Act, 2013. The tribunal shall declare a company as sick company within 60 days of the application. It is to be noted that under SICA there is no such provision with regard to sickness and instead of Tribunal the authorities are BIFR/AAIFR.

RBI DEFINITION OF INDUSTRIAL SICKNESS: MEANING

 

There are various criteria of sickness. According to the criteria accepted by the Reserve Bank of India “a sick unit is one which has reported cash loss for the year of its operation and in the judgment of the financing bank is likely to incur cash loss for the current year as also in the following year.”

Industrial Sickness: Meaning

 

Growing Importance of Industrial Sickness

 

(a)   World over sickness in industries is a recognized fact. Often, It is inevitable for various reasons. In all economies, business failure is a reality of commercial life

(b)  The technological development render -

i.        Old technologies obsolete

ii.      Industrial recessions make some unviable

iii.     International trade policies make some uncompetitive iv. Tardy progress in some related sectors shrink markets for others

(c)   These features of Industrial sickness are generally combated by

i.        Closing down unviable units

ii.      Adopting new technologies

iii.     Diversifying products.

iv.     Nursing a few that are victims of trade cycles till recoveries set in

v.       Revive those that are sustainable with appropriate measures

(d)  A sick unit incurs cash losses and fails to generate internal surplus  on a continuing bass

(e)   There are different forms, varieties and degrees of industrial sickness.

(f)   Various authorities have viewed industrial sickness differently but in sense and substance their findings are more or less the same.

(g)  Factually, no single factor is responsible for malady of industrial sickness.

2. Industrial Sickness: Internal Causes

Planning and Implementation Stage

1. Technical Feasibility

(a)   Inadequate technical know-how

(b)  Locational disadvantage

(c)   Outdated production process

 

Economic Viability

 

(a)   High cost of inputs

(b)  Breakeven point too high

(c)   Uneconomic size of project

(d)  Underestimation of financial requirements

(e)   Unduly large investment in fixed assets

(f)   Overestimation of demand

(g)  Cost over runs resulting from delays in getting licenses/sanctions etc.

(h)  Inadequate mobilization of finance

 

Commercial Production Stage

Production Management

(b)  Inappropriate product-mix

(c)   Poor quality control

(d)  Poor capacity utilization

(e)   High cost of production

(f)   Poor Inventory management

(g)  Inadequate maintenance and replacement

(h)  Lack of timely and adequate modernization

(i)    High wastage of material in production process

 

Financial Management

 

(b)  Poor resources management and financial planning

(c)   Faulty costing

(d)  Liberal dividend policy

(e)   General financial indiscipline

(f)   Application of funds for unauthorized purposes

(g)  Deficiency of funds

(h)  Overtrading

(i)    Unfavourable gearing

(j)    Inadequate working capital

(k)  Absence of cost consciousness

(l)    Lack of effective collection machinery

 

Personnel Management

 

(a)   Excessively high wage structure

(b)  Inefficient handling of labour problems

(c)   Excessive manpower

(d)  Poor labour productivity

(e)   Poor labour relations

(f)   Lack of skilled/technical competent personnel

 

Marketing Management

 

(a) Dependence on limited number of customers

(b)Dependence on limited number of products

(c)  Poor sales realization

 

(d)  Defective pricing policy

 

(e)  Booking large order at fixed price during inflation

 

(f)   Weak market organization

 

(g)  Lack of market feedback and market research

 

(h)  Lack of knowledge of marketing techniques

 

(i)   Unscrupulous sales/purchase practices

 

General Management

 

(a)  Over centralization

 

(b)  Lack of professionalism

(c)  Lack of feedback to management

 

(d)  Lack of proper management information systems

 

(e)  Lack of controls

 

(f)   Lack of timely diversification

 

(g)  Excessive expenditure of R&D

 

(h)  Divided loyalties

 

(i)   Incompetent management

 

(j)   Dishonest management

Industrial Sickness: External Causes

Infrastructure Bottlenecks

(a)  Non-availability irregular supply of critical raw materials or other inputs

 

(b)  Chronic power shortage

 

(c)  Transport bottlenecks

 

Financial Bottlenecks

 

(a)  Non-availability of adequate finance at the right time

 

(b)  Non-cooperation from Banks and Financial Institutions

 

Government Controls

 

(a)  Government price controls

 

(b)  Improper fiscal duties

 

(c)  Abrupt changes in Govt. policies affecting costs/prices/imports/exports/licensing

(d)  Procedural delays on the part of the financial/licensing/other controlling or regulating authorities.

Market Constrains

 

(a)  Market saturation

(b)  Technological obsolescence

(c)  Recession

(d)  Fall in domestic/export demand

Extraneous Factors

(a)  Natural calamities

(b)  Political situation (domestic as well as international)

(c)  Sympathetic strikes and Multiplicity of labour unions

(d)  War

Prediction of industrial sickness: Multiple Discriminant Analysis (MDA)

Introduction

A.   The computation and analysis of certain ratios based on the information taken from financial statements allow the analyst to predict sickness or business failure.

B.    The ratios are considered independent of each other, will not permit to express the

C.    It would be more useful if the important ratios are combined together to measure whole situation in a single measure. the probability of sickness or insolvency.

D.   To overcome this difficulty Edward I. Altman (1968) developed Z score model". It is called as 'multiple discriminant analysis (MDA).

E.    It is a linear analysis used to develop with five variables.

F.    MDA computes the discriminant coefficient while the independent variables are the actual values taken from the financial statements.

G.   The model was developed basing on empirical studies, to predict the sickness of a unit in advance.

H.   This model is used in order to detect the financial health of industrial units with a view to prevent the industrial sickness.

Formula

 

Altman Z score model is expressed as under:

Z = 1.2x₁ + 1.4x + 3.3x + 0.6x + 1.0X_5.

X₁= Working capital/Total assets

X    Retained earnings/Total assets

X₃ = Earnings before interest and taxes/Total assets X₄= Market value of equity/Book value of total debt X₅ = Sales/Total assets.

Analysis

 

The sickness is predicted basing on value of Z score model can be analysed as follows:

 

(a)  If Z score is more than 2.99          - there is no danger of bankruptcy

 

(b)  If Z score is below 1.81     - there is a definite failure

 

(c)  If Z score is between 1.81 and 2.99           - it shows the grey area

 

Guidelines

 

Altman developed a guideline for Z score:

 

(a)  If score is above 2.675      - firms can be classified as financially sound

 

(b)  If score is below 2.675      - the firm is heading towards bankruptcy

 

(c)  The lower the Z score, there is a greater possibility of bankruptcy and vice versa.

 

Conclusion

 

(a)           Altman's model has established itself as the leading multivariate predictor model of corporate failure and it has been the subject of numerous tests around the world.

(b)          It would be useful to employ the Altman model in evaluating Indian firms and endeavour establish the reliability of the model.

(c)           It could be that the cut-off point for the Z score should be altered from that established in the original study.