VIVEKANANDA INSTITUTE OF PROFESSIONEL STUDIES

SCHOOL OF LAW AND LEGAL STUDIES

FINANCIAL DISTRESS
SUBJECT: FINANCIAL MANAGEMENT

SUBMITTED TO:

Dr. Shefali Sachdeva

(Faculty Member ,VIPS)

SUBMITTED BY:

Vishesh Kumar
Enrollment no.-13917703519
BBA LLB, 2-M
 DECLARATION

I hereby declare that the project report entitled "FINANCIAL DISTRESS"

submitted by Vishesh Kumar to VIVEKANANDA INSTITUTE OF
PROFESSIONAL STUDIES, NEW DELHI as PSDA Submission for BBA
LLB (II SEMESTER) in FINANCIAL MANAGEMENT is a project work
carried out by me under the guidance of Dr. Shefali Sachdeva.
 ACKNOWLEDGMENT

I would like to thank my Parents ,who were obviously the one has always
guided me to work on the one has always guided me to work on the right path
of life. Without his grace this project could not become a reality. Next to him
are my parents, whom I am greatly indebted for me brought up with love and
encouragement to this stage. I am feeling oblige in taking the opportunity to
sincerely thanks to Dr. Shefali Sachdeva .At last but not the least I am
thankful to all my teachers and friends who have been always helping and
encouraging me throughout the year. I have no valuable words to express my
thanks, but my heart is still full of the favours received from every person.
ABSTRACT:

The significance of project finance cannot be overemphasized as there is a paradigm

shift in financing capital intensive projects by both private and public entities using
project finance schemes as opposed to traditional corporate finance across the world.
Unfortunately, a number of such projects are engulfed into financial distress at some
point in their life cycles. In order to address this issue, this paper examined the elements
of project financial distress, its major signs, sources, and as well as suggesting ways to
eliminate these undesirable consequences. The methodology used is the critical analysis
of empirical literature. Findings of this study provide basis for addressing financial
distress conditions by restructuring financially distress projects. The findings also
indicate that restructuring can be looked at in four broad dimensions notably; financial,
asset, operational, and managerial.

INTRODUCTION:

Financial distress is a hot topic these days in finance and the project’s health is very
important for investors as well as management. Investors posit money in those projects
which are financially healthy as the risk of default is minimized for them, while
management must be able to identify causes of distress which can be controlled by taking
different measures .However, the fact that many projects encounter financial distress
requires further investigation. This paper deals with the elements of project financial
distress as its major signs and sources as well as it suggests ways to eliminate the
consequences. The results provide an effective way to resolve financial distress by
restructuring it. Apparently, this option should be preferred as long as it is considered to
be more advantageous than liquidation. The report also shows that restructuring can be
looked at in four broad categories:

1. Managerial
2. Operational,
3. Asset
4. Financial

The paper describes each category; it determines the right time to use each of them; it
explains their benefits and last; it provides guidelines to consult when implementing
them.
OBJECTIVE OF THE STUDY:

1. This paper examined financially distressed project through the review of sufficient
literature about financial distress and project finance arrangement schemes,
thereby outlining signs and sources of financial distress associated with projects
and suggested appropriate remedies to projects deeply rooted in financial distress
condition.

2. In order to achieve this principal objective, however, the paper explored existing
and well known restructuring methodologies to turn around the fortunes of
financial distress projects into successful ones.

3. Additionally, the paper discussed the way desired financial health of a project
finance scheme could be achieved particularly if it is in financial distress
condition. Finally, the paper offered appropriate conclusions and
recommendations.

4. The other objective of the paper clearly indicates that the outcome of the study
will be of benefit to all stakeholders.

LITERATURE REVIEW AND FINDINGS

This section discusses project finance, the state and signs of financially distress projects
and how to eliminate financial distress conditions. Finally, this section looks at how
stakeholders to project finance can restructure a project in financial distress condition in
order to turn around the fortunes of the company. These discussions are based on the
hypothesis that the conceptualization and restructuring of a financially distressed project,
providers of finance and sponsoring companies must have insight into the probability of a
possible borrower default. As a consequence, both finance providers and sponsoring
companies alike will have to make provision for possible losses mitigation. However,
when a project is plunged into financial distress situations borrower default is high
therefore both parties will have to decide either to restructure or exercise the foreclosure
on the assets to manage the assets or dispose-off the assets to external investors.
DEFINITIONS
Financial distress is a term in corporate finance used to indicate a condition when
promises to creditors of a company are broken or honored with difficulty. If
financial distress cannot be relieved, it can lead to bankruptcy. Financial distress is
usually associated with some costs to the company; these are known as costs of
financial distress.
Distress - taking someone's goods to pay for debt. Financial distress may result in
default in payment of bond interest or non payment of preference dividend. •
Characterized by:
1. Non payment of dividends
2. Default on debt obligations
3. Cessation of operations
Financial distress is the polished term for bankruptcy. Bankruptcy refers to those
firms that were legally bankrupt and were either placed in receivership or had been
granted the right to recognize under the provision of Bankruptcy Act.

IT CAN BE DISTINGUISHED IN TWO TYPES BASED ON ITS INSOLVENCY:

1. Value Based Insolvency

Value-based insolvency occurs when a firm has negative net worth, so the value of assets
is less than the value of its debts.

2. Flow Based Insolvency

Flow-based insolvency occurs when operating cash flow is insufficient to meet current
obligations. Flow-based insolvency refers to the inability to pay one's debts.
What Happens in Financial Distress?
These include one or more of the There are many responses to financial distress
that a firm can make. following turn around strategies.

1) Asset expansion policies

2) Operational contraction policies
3) Financial policies
4) External control activity
5) Changes in managerial control
6) Wind up company*

WHO WOULD GET AFFECTED FROM FINANCIAL DISTRESS?

Financially distressed firms will definitely face some type of cash liquidity problem.
Several remedies are available. One, the company can reduce its annual dividend.
Another option is to restructure existing debt facilities so that less interest is paid. The
equity and debt markets may also be tapped to raise further funding.

* The final and least desirable strategy a financially distressed firm will follow is to wind up its
operations and go into some form of bankruptcy. It may not always end in the disappearance of a
company, and firms may be split up, sold on to new buyer, or restructured during the process.
Example

Kingfisher Airlines' losses in Q3, taking the total loss to $240 million previous
year, as the ailing Indian carrier was squeezed by high fuel costs, a weaker rupee
and competition. Current market price is 19.95 as per BSE and 20.05 as per NSE
till on 14 march, 2012 by latest. Kingfisher Airlines has opted to do Financial
restructure to cover their loss margin.

STATE,TYPES AND SIGNS OF FINANCIAL DISTRESS

Financial distress is a situation in which the firm is unable or faces difficulty in paying
off its financial obligations and if the conditions aren't improved upon, it could also lead
to bankruptcy.

Business & Operational Losses

The euro zone crisis along with the rise of competitors such as Expedia and budget
airlines has led to significant business and operational losses for the company. Due to
increasing stiff competition the company is getting squeezed. The gross profit margins
are 21.8% for 2012 and the EBIT margin is extremely thin at 1.8%. Selling General and
administrative expenses are taking a company for the run. Out of the last five years, the
first two the company earned a net income of less than 1% and in the last three it has
steadily and drastically increasing net losses.

Example

E Honda is a good example of following a contraction policy. First quarter results for
2009 were absolutely dire. Car sales had dropped by 10 per cent, and 400,000 fewer cars
were sold than the same period in 2008. There was also the very strong possibility that
the company would make an annual loss for the first time since it was founded in 1948.
In response, Honda cut global production by 420,000 units and closed its UK plant for
four months in order to reduce inventory levels. The employees of the British plant were
still paid during this period and, as a result, no redundancies were made.
Selling of Operational Non-Current Assets

On 12 July 2011, the Group announced its intention to dispose of certain hotel and
surplus assets, which are expected to generate net proceeds of up to £200m over a six to
eighteen month period. On 29 September 2011. the Board announced its decision not to
declare any further dividend payments whilst the Group re-builds its balance sheet. Over
500 underperforming performing were removed from the portfolio and since October
2011 149 stores have been closed, including head office properties and one-sixth of the
company will be let gone. It also returned six aircraft back to the lessors. In 2012 the
Cash flow from investments

Example

The joint venture between Fiat and Chrysler is a good example of an asset expansion
policy. In 2009 carmakers were facing a bleak prospect, with sales down across the
world. The US and British governments had already bailed out their own automobile
industries, and many carmakers had reduced production to only part of the year. By
entering into a joint venture, Fiat and Chrysler were able to expand their sales revenue at
a time when they needed it the most.

SIGNS
1. Sudden Expenses: Life is full of uncertainty, and you cannot plan 100%. Various
insurance covers like health insurance, critical illness cover, accident insurance, etc. can
hedge the risk. Still some corner is left for unplanned expenses. It put a strain on your
existing finances. If you have planned for these sudden expenses, then there is no reason
to worry. Now you must be wondering how an unforeseen expense is an early sign of
financial distress. The early sign is our thought process that we will never face such
situations in life. In short, we ignore the importance of financial planning that help in an
emergency. Therefore, depending on your requirement, you may opt for insurance covers
that assist in managing sudden expenses.

2. The increase in no of dependents: Though quite a unique point but i observed that

increase in no of dependents is a very early sign of financial distress. It does not
necessarily means an extension of the family. If one of the spouse stop working or
retirement of parents also implies a possible increase in no of dependents. You should
always foresee such events and plan in advance.
3.Employment Prospects: A bleak employment prospect is the earliest signs of financial
distress. Have you ever wondered what happened to jobs like clerks, typists, telephone
operators, etc. The sectors/industry like heavy engineering, hand loom, music
distribution, etc. are almost dead. According to experts, technology will eclipse some
other sectors in future. There is a consensus that banking sector will undergo a tectonic
shift in next 5-7 years. It will be more and more technology driven. Therefore, job
prospects in banking look bleak. As i shared in my previous post that Job Loss Insurance
Cover is not available on a stand-alone basis in India. Therefore, poor employment
prospects require mid-career shift but how many people foresee this.

WAYS TO OVERCOME(for Individuals)

If you are going through a financial stress or are unable to manage your financial
debt, the first steps should be to have a conversation about it. According to financial
planners, most people are ashamed to talk about their money mistakes and find it
uncomfortable to talk about them.

Here’s what you should do if you are in financial distress:

1. Talk about your money mistake

If you have not made the right money decisions in your life, remember that you are not
alone.
“From businessmen to salaried individuals, you can have financial stress or get into debt.
If the breadwinner of the house has taken a loan or have financial issues, they are not
usually open to talk about
2. Start by paying off your debt
If you have taken too many loans, you do not need to panic. You can begin by writing
down the details of all the loans that you have to repay, along with the amount and the
interest rate. If you do not have enough income flow to repay the loans, either look for
ways to increase your income or to sell off your existing assets.
“
.
3. Cut down on your expenses
Another way is to cut down your expenses till you pay off the debt. “You need to keep a
check on your expenses till the time you can reduce the debt,"
(FOR FIRMS)
1. Debt restructuring is the process of reorganizing the whole debt capital of the
company. It involves reshuffling of the balance sheet items as it contains the debt
obligations of the company. A company's financial manager needs to always look
at the options to minimize the cost of capital and improving the efficiency of the
company as a whole which will in turn call for the continuous review of the debt
part and recycling it to maximize efficiency.

2. According to experts, debt compromises your mental peace. “You keep hopping
jobs assuming you are not earning enough. However, because you are not able to
get mental peace, you are not able to do your job well. It is a cycle to get out. In
.
On the elimination or control of political risks ,I suggests that firms should consider the
following to better manage this kind of risk;
a) Be proactive and avoid situations with overt political risk

b) Diversify political risks.

c) Deal with risks on an ongoing basis.

d) Understand macro and a micro political risk environment.

e) Understand insurance as a powerful way to mitigate politics.

CASE
Thomas Group Plc was created in 2007 by the merger of Thomas Cook AG and
MyTravel Group Plc. Our five parameters for financial distress are as follows Altman Z
score (for non-manufacturers)

The Z score value gives the probability of a firm getting bankrupt within the next two
years. If the value of the Z score is lower than 1.8 for a private sector company. it is said
to be in the distress zone. Based on our calculations, the Z score value of Thomas Cook
was -0.987 for the fiscal year ending in 2012 which means that the company has higher
chances of bankruptcy. The weaker Z score can be attributed to the negative working
capital, poor asset turnover, net losses etc. Mountains of Debt
Mountains of debt are piling in the company's balance sheet. The total debt to equity ratio
has increased from 103.8% to 272.7% in 2012. Before the global financial crises Thomas
Cook was sitting on a cash pile of 394 million pounds. In the wake of the crises, the
market condition deteriorated it faced a cash crunch and the company had to take massive
short term and long term debt financing in 2011 and 2012 to be afloat.

Business & Operational Losses

The euro zone crisis along with the rise of competitors such as Expedia and budget
airlines has led to significant business and operational losses for the company. Due to
increasing stiff competition the company is getting squeezed. The gross profit margins
are 21.8% for 2012 and the EBIT margin is extremely thin at 1.8%. Selling General and
administrative expenses are taking a company for the run. Out of the last five years, the
first two the company earned a net income of less than 1% and in the last three it has
steadily and drastically increasing net losses.

Selling of Operational Non-Current Assets

On 12 July 2011, the Group announced its intention to dispose of certain hotel and
surplus assets, which are expected to generate net proceeds of up to £200m over a six to
eighteen month period. On 29 September 2011. the Board announced its decision not to
declare any further dividend payments whilst the Group re-builds its balance sheet. Over
500 underperforming performing were removed from the portfolio and since October
2011 149 stores have been closed, including head office properties and one-sixth of the
company will be let gone. It also returned six aircraft back to the lessors. In 2012 the
Cash flow from investments
 CONCLUSION

As a result of recent corporate failures such as Enron, WorldCom, Lehman Brothers and
coupled with the failure of project finance transaction like the Eurotunnel in 2006,
financial distress is now a very hot topic in the finance literature. Financial distress is
therefore a condition where a company cannot meet or has difficulty paying off its
financial obligations to its creditors. This situation as and when it happen calls for some
form of investigation so as to prescribe appropriate remedy in eliminating it.

This paper examined the elements of project financial distress, its major signs, sources,
and as well as suggesting ways to eliminate these undesirable consequences. The findings
therefore provide a basis for addressing financial distress conditions by restructuring
financially distress projects. Additionally, this option should be preferred as long as
stakeholders believe it is a better alternative than liquidation. The findings also indicate
that restructuring can be looked at in four broad dimensions notably; financial, asset,
operational,

Based on the above five areas we conclude that Thomas Cook PLC is financially
distressed. Reduced consumer spending coupled with stiff competition from budget
airlines and online portals is hurting the company. Miniscule operating margins and
mounting levels of debt are putting a huge dent in the net income (loss) leaving nothing
for shareholders. However the company is restructuring itself and trying every means to
be able to back on its feet. Good news is the cash problem is solved. Market has gained
confidence and much of it can be seen it the rising share price from near crises level of 20
pounds to 150 pounds in fiscal year 2012.
 REFERENCES

WWW.WIKIPEDIA.COM

Financial Distress: Major Sign, Sources, & Ways to Eliminate Them.

Available at htt://ssrn.com/abstract=2149966.

Bardia, S. C. (2012). Predicting financial distress and evaluating long-term solvency: An

empirical study. IUP Journal Of Accounting Research & Audit Practices, 11(1), pp.
47-61.

Beaver, W. H., Correia, M., & McNichols, M. F. (2010). Financial statement analysis
and the prediction of financial distress. Foundations & Trends in Accounting (pp. 99-
102).

Bhunia, A., Khan, I., & Mukhuti, S. (2011). Prediction of financial distress -A case
study of Indian companies. Asian Journal Of Business Management, 3(3), pp.
210-218.

Holder-Webb, L., T. J. Lopez, and P. R. Regier, (2005). The performance

consequences of operational restructurings. Review of Quantitative Finance and
Accounting 25: 319-339.

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