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Financial Distress: Vishesh Kumar 13917703519 Bba LLB, 2-M
Financial Distress: Vishesh Kumar 13917703519 Bba LLB, 2-M
Financial Distress: Vishesh Kumar 13917703519 Bba LLB, 2-M
FINANCIAL DISTRESS
SUBJECT: FINANCIAL MANAGEMENT
SUBMITTED TO:
SUBMITTED BY:
Vishesh Kumar
Enrollment no.-13917703519
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. 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 favors 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.
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.
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.
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.
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.
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.
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.
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.
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
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.
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.
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
Available at htt://ssrn.com/abstract=2149966.
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.
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