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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.