2. 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.
3. Concept of Sickness
Meaning – ‘disease’ or act of ‘being ill’.
Sustainable amount of loanable funds of the financial
institutions is locked up in sick industrial units causing not
only wastage of resources but also affecting the healthy
growth of the industrial economy.
RBI– Industrial unit as sick, ‘if it has incurred cash loss for
one year and in judgment of financial bank, it is likely to
continue to incur cash loss in the following two years and
it has imbalance in its financial structure such as current
ratio being less than 1:1 and worsening debt equity ratio.
4. Symptoms of sick unit
Low sales turnover of the unit
Failure to honour the bills on maturity date
Unusual delays in the submission of stock statements
Over valuation of stock
Frequent requests by firm to bank to extend overdraft
facilities
Return of bills drawn by a unit on its buyers
5. External Causes:
Irregular availability of raw materials
Availability of raw materials at high prices
Government’s policy in terms of the fiscal policy and the
imposition of excise duties, import duties etc.
High cost of manufacture
Internal Causes:
Poor management, control and direction
Lack of coordination
An improper choice of techniques
Unsuitable product mix
Wrong location of unit
Improper and ineffective demand forecasting of product
Inaccurate estimation of working capital
Break down of production due to shortage
Poor cash management
6. Industrial Sickness In India
Exogenous factors:
Relate to government policies, change in
investment pattern, shortage of power, transport,
raw materials and deteriorating industrial relations.
Likely to affect all units in an industry.
Endogenous factors:
Relate to mismanagement, diversion of funds,
wrong dividend policy, lack of provision for
depreciation on machinery and other equipments,
overestimation of demand.
Most important cause of sickness is the
incompetence or the cupidity of the management.
7. Measures to prevent sickness
Deterrent penalties to parties
Financial and management restructuring
Preparation and implementation of plan
Availability of professional management expertise
Monitoring and nursing sick units
Accord priority in allocation of scarce resources
Concessional rate of interest charged
Penal action by government
8. RBI’s Guidelines on Sickness and
an Overview
Criteria suggested by RBI:
Cash losses ie. Losses before charging depreciation
for three consecutive years
Current ratio falling below 1 ie. Negative working
capital
Deterioration in Debt/ Equity (total outside liabilities
to net worth) ratio
Illustration:
9. Firm A
Amt in ‘000
Year 1 2 3 4
Current Assets, Loan and
advance
1308 731 1071 1015
Less: Current Liabilities 2458 2502 3401 4640
Working Capital (negative) -1150 -1771 -2330 -3625
Debt 295 430 504 513
Equity 424 -525 -1324 -2788
Total Capital Employed 719 -95 -820 -2275
Cash Loss 922 1016 646 1305
Current ratio 0.53 0.29 0.31 0.21
10. Firm B
Amt in ‘000
Year 1 2 3 4
Current Assets, Loan and advance 2340 5476 2913 2657
Less: Current Liabilities 1618 4616 3216 2420
Working Capital 722 860 -303 237
Debt 4345 5481 4868 7265
Equity 3889 2929 2408 459
Total Capital 8234 8410 7276 7724
Cash Profit/(-)Loss 198 -470 -496 -1498
Current Ratio 1.45 1.19 0.91 1.09
Debt/Equity Ratio 1.12 1.87 2.02 15.80
11. Firm C
Amt in ‘000
Year 1 2 3 4
Current Assets, Loan and advance 12262 12186 18821 20959
Less: Current Liabilities 12681 12500 16921 17190
Working Capital -419 -314 1900 3769
Debt 8558 9782 13682 17838
Equity 1039 622 -1728 18440
Total Capital 9597 10404 11954 36278
Cash Profit/(-)Loss 1002 519 -1436 -763
Current Ratio 0.97 0.97 1.11 1.22
Debt/Equity Ratio 8.24 15.73 0.97
12. Firm D
Amt in ‘000
Year 1 2 3 0
Current Assets, Loan and advance 31278 29730 41570 38908
Less: Current Liabilities 22010 25033 32798 33078
Working Capital 9268 4697 8772 5830
Debt 19567 18229 25107 27482
Equity 6236 3584 24 24876
Total Capital 25803 21813 25131 52358
Cash Profit/(-)Loss 6524 -1348 -1973 -3779
Current Ratio 1.42 1.19 1.26 1.18
Debt/Equity Ratio 3.14 5.09 1046.00 1.10
