Industrial Sickness

Presenter:
Farana Kureshi
Definition of Sickness
 There are two ways of looking at insolvency:
 Stock-based insolvency: When the firm has negative net
worth. i.e assets are less than the liabilities
 Flow-based insolvency: When operating cash flows are not
enough to meet its obligations
 Reserve bank of India has defined a sick unit as ‘One
which has incurred cash losses for one year and, in the
judgment of financing bank, is likely to incur cash loses for
the current as well as the following year and or there is an
imbalance in the unit’s financial structure, i.e. current ratio is
less than 1 & debt-equity ratio is worsening.
Definition of Sickness
 The Varsheny Committee constituted by the State Bank of
India defined sick unit as ‘As a unit which fails to generate
internal surplus on a continuing basis and is dependent for its
survival on frequent infusion of external funds.’
 Financial Institutions for the purpose of term-loan, classify a
sick unit after considering any of the following symptoms:
1. Default in meeting 4 consecutive half-yearly installments of
interest or principal of institutional loans
2. Cash losses for a period of 2 years or continued erosion of
net worth
3. Increasing arrears of statutory and other liabilities for a
period of 1 to 2 years.
Causes of Sickness
1. Unfavourable external environment
 Shortage of key inputs like raw materials, power, etc
 Changes in governmental policies
 Emergence of large capacity, leading to intense competition
 Development of new technology
 Sudden decline in orders
 Shifts in consumer preference
 Natural calamities
 Adverse international developments
 Reduced lending by financial institutions
Causes of Sickness
2. Managerial deficiencies
 Deficiencies in Production
 Deficiencies in Marketing
 Deficiencies in Finance
 Deficiencies in Personnel
RBI Study of Causes of Sickness
 Study covered 378 units, on the causes of industrial sickness
revealed the following picture:
Number Percentage
Mismanagement and managerial deficiencies 197 52
Faulty initial planning and other technical 52 14
drawbacks
Labour trouble 9 2
Market recession 86 23
Others (infrastructural factors, raw material 34 9
shortage, etc.
Total 100 100
Symptoms of Sickness
 Delay or default in payment to suppliers
 Irregularity in bank account
 Delay or default in payment to banks
 Frequent requests to banks or FI for additional credits
 Decline in capacity utilization
 Poor maintenance of plant & machinery
 Low turnover of assets
 Accumulation of inventories
 Inability to take trade discount
 Excessive turnover of personnel
 Decline in the price of equity shares & debentures
 Prediction of Sickness
 Univariate Analysis: William Beaver compared financial ratios of a
sample of 79 firms that failed with the financial ratios of a sample
of 79 non-failed for the same period of time.
 It suggests that financial ratios had the power to signal an
impending failure.
 L.C. Gupta, in an extensive study with Indian data, selected a
sample of 41 textile companies of which 20 were sick and 21
were non-sick to test the predictive power of 63 financial ratios.
 The study revealed that the EBDIT/Sales and OperatingCF/Sales
are the two important ratios which predict sickness
Prediction of Sickness
 Multivariate Analysis: Seeks to predict financial sickness using
a methodology that considers the combined influence of
various ratios.
 Classic study was conducted by E.I Altman.
 Altman’s Z score model helps in bankruptcy prediction.
 He studied a sample of 33 bankrupt firms along with a paired
sample of 33 non-bankrupt firms and examined 22 financial
ratios with a view to selecting 5 which jointly possessed the
maximum power to predict bankruptcy
Altman’s Z Score original model
 T1 = Working Capital / Total Assets
 T2 = Retained Earnings / Total Assets
 T3 = Earnings Before Interest and Taxes / Total Assets
 T4 = Market Value of Equity / Total Liabilities
 T5 = Sales/ Total Assets
 Z score bankruptcy model:
Z = 1.2T1 + 1.4T2 + 3.3T3 + 0.6T4 + .999T5
 Zones of Discrimination:
 Z > 2.99 -“Safe” Zones
 1.81 < Z < 2.99 -“Grey” Zones
 Z < 1.81 -“Distress” Zones
Critique of Bankruptcy Prediction
Models
 Results of such unguided research efforts are often
inconsistent, and impossible to generalize
 These studies are statistically flawed because they are
retrospective in nature
 Only financial ratios are considered
 Historical data
 Studies companies which are already sick
Revival of a Sick Unit
Step 1. Viability Study:
 Market Analysis
 Production/Technical Analysis
 Financial Analysis
 Personnel Organization
 Environment
Revival of a Sick Unit
Step 2. Revival Programme
 Settlement with creditors
 Provision of additional capital
 Divestment & disposal
 Reformulation of product-market strategy
 Modernization of plant & machinery
 Reduction in manpower
 Strict control over costs
 Streamlining of operation
 Improvement in managerial systems
 Change of management
Revival of a Sick Unit
Debt Restructuring
 Interest rate relief
 Deferment of past interest dues
 Waiver of penalties
 Re-schedulement of loan repayment
 Reduction in loan amount
 Turnaround Stories
TVS Suzuki
 Started its operations in 1987-88
 Its performance deteriorated in the following three years
 By early 1991 situation was really bad because of intense
competition
 Determined to fight the competition and improve
performance, company took a series of steps:
1. A six month, week-by-week cost reduction drive focused on
raw material cost, manpower cost, etc. This led to a drop of
30% in operating costs
 Turnaround Stories
2. Massive exercise in value engineering was undertaken in
tandem with Suzuki. This resulted in a saving of 10 million
per month.
3. A product improvement strategy to introduce a new model
every few years, to build market share
4. A renewed marketing drive backed up by a high advertising
outlay and a new marketing and vendor policy
Due to these initiatives and the dynamic leadership of Venu
Shrinivasan, the company emerged as a healthy, vibrant
organization
Thank You