Description
classify a company sick industrial company, weak unit, sick SSI unit, factors leading to bankruptcy. It explains various factors of bankruptcy, cause and effect of financial distress, effects of financial distress. It also includes J. Argenti Score Board and wilcox model.
FINANCIAL DISTRESS & RESTRUCTURING
• Bankruptcy:Firm is unable to meet its current obligations to the creditors. May occur due to
Dun&Bradstreet Inc. survey) • 1. Economic factors 37.1% • 2. Financial factors 47.3% • 3. Neglect, disorder & fraud 14.0% • 4. Other factors 1.6% • Total 100.00%
Sick industrial company
• Sick Industrial Companies Act (Special Provisions) Act, 1985, defines as : • “an Industrial (being registered for not less than 5 years) which has at the end of any financial year, accumulated losses equal to or exceeding its net worth.”
Weak unit
• A non- SSI is weak, if its accumulated losses at the end of accounting year resulted in erosion of 50% or more of its net-worth. • Weak units include SICA units, firms (partnership business), proprietorship concerns. • Weak = potentially sick.
Sick SSI Unit (as per RBI)
• 1. Borrowal accounts has become doubtful advance – principal or interest has remained overdue for more than 2.5 years, and • 2. Erosion of net-worth due to accumulated cash losses to the extent of 50% or mote of its peak net-worth during preceding 2 accounting years. These norms are revised by RBI from time to time. Keep updated.
Update / Amendments
• It was proposed to revise the definition of “sick industrial company” by an amendment through Companies Bill, 2009 introduced in Parliament and awaiting passing of the bill. Thereafter, whenever any financial institution or bank or creditor issues notice to any company for payment of interest or loan, company will be „sick industrial company? after expiry of the notice, if the amount demanded is not paid by company.
Factors leading to bankruptcy
• External: • 1. Change in government policies, 2. Increased competition, 3. Scarcity of raw material, 4. Prolonged power cut, 5. Changes in consumer buying pattern, 6. Shrinking demand, 7. Natural calamities, cost overruns, inadequate funds.
Factors leading to bankruptcy
• • • • • • • Internal: 1. Mismanagement, 2. Fraudulent practices, 3. Misappropriation of funds, 4. Labor unrest, 5. Technical obsolescence, 6. Dispute among promoters.
RBI Survey / Study of Reasons
• • • • • • 1. Mismanagement 2. Faulty initial planning 3. Labor trouble 4. Market recession 5. Other reasons Total 52% 14% 2% 23% 9% 100%
Symptoms - production
• • • • Low capacity utilization High operating cost Failure of production lines Accumulation of finished goods
Symptoms – sales/marketing
• • • • Declining / stagnation in sales Loss of distribution network to competitors Poor quality products Poor aesthetic presentation
Symptoms - finance
• • • • • • 1. High borrowing against assets 2. High borrowing at high interest rates 3. Failure to pay term loans, interest 4. Failure to pay current liabilities 5. Failure to pay salary, wages 6. Failure to make statutory payments.
Symptoms - others
• • • • • • • • 1. Declining market share 2. Attrition of key personnel 3. Persistent cash losses 4. Changes in accounting policies a) deferred revenue expenses, b) longer life of assets, lower depn. c) multiple shift depn./single shift depn. d) repairs and maintenance treated as capex.
Symptoms - others
• Change in accounting years • ( to cover 2 seasons – Navneet Prakashan may change accounting year from 1st April to 30th June to cover 2 seasons)
Prediction of Bankruptcy
• International models: Beaver Model: • Beaver used 30 ratios, classified under 6 categories. He tested these ratios to predict failure of company. Ratio of cash-flow to total debt was the best single predictor of failure. Financial ratios are useful in prediction 5 years prior to the event.
Wilcox Model
• Net liquidation value of a firm, i.e. liquidation value of assets minus liquidation value of liabilities. It is market value of both at a point of time.
Financial distress – issues faced
• 1. Inability to meet debt obligations – temporary cash-flow problem or reduction in asset value than debt + interest. • 2. Temporary cash-flow can be solved by rescheduling creditors. • 3. If asset value is lower, who will bear the losses? In what proportion? 4. Business valuation.
Financial distress – issues faced
• 4. Business valuation, if continued or if closed, to ascertain if found profitable, to continue or to liquidate? • 5. File protection under Chapter 11 of Bankruptcy Act or go for informal procedure or work under directions of Court or BIFR?
Financial distress – issues faced
• 6. To ascertain whether existing management be left in charge or trustee should be appointed – to ascertain controlling force and decide to keep that way or change?
Settlement without going through bankruptcy
• 1. Identify the problem – temporary or not. Like Doctor?s decision to treat a patient as OPD or hospitalization. • 2. Decide informal process or through Court? • 3. Through Court–costs, opposition by creditors, disruptions. • 4. Company with strong fundamentals and good management team with integrity.
Settlement without going through bankruptcy
• Creditors may “workout”something: 1.Extension of time for payment for supplies, 2. Remission of interest, 3.Remission of compound interest, 4. Reduction of interest, 5. Do not invoke bank guarantee, 6. Take equity in place of debt, fully or partly, 7.One-time-settlement(OTS).
Settlement without going through bankruptcy
• • • • • • Creditors’ meeting: Committee of 5 representatives, Creditors? list, amounts due, secured or not, Preferential creditors Government dues Secured creditors and assets charged to those creditors.
Settlement without going through bankruptcy
• 5. Valuation of assets / disposal – payment to creditors in order of priority, surplus to go to common / equity shareholders.
Continued operations
• 1. Improvement in capital equipments • 2. Marketing and logistics • 3. Administration spruce up, management change. • 4. Creditors and bankers are informed. • 5. They cooperate – cost of liquidation can be saved.
Continued operations
• 6. Formal plan is drafted and presented to creditors for composition, extension of new line of credit or help. 7. Talk “win-win” situation. 8. No stigma of bankruptcy on debtor. 9. Simple, cheap, informal process. • 10. Banks agree to restructure than to write down or classify as NPA. 11. Hold out problem – creditors not agreeing to plan.
Informal liquidation
• Value of business is more when closed than when running. • Assignment is possible when firm is small and business is not complex. • Machinery / inventory is in good condition. • Assignment does not result in full and legal discharge of debt.
Cause and effect of financial distress
• Top-down approach: • 1. Macro economic growth, government policies (FDI not allowed in retail, restriction on courier business to protect postal revenue), regulations • 2. Industrial factors, business environment • 3. Macro level factors, liquidity and recession.
Cause & effect of financial distress
• Top-down approach: • 4. Monetary policy and liquidity of nation • 5. Reversal fortune – from diversification to focus – concentrate on core brands and business: i) managerial economies of scale, • ii) economies of scope in production and marketing, iii) financial synergies.
Industry level causes of Financial Distress
• 1.Competition: - 1. barriers to entry, 2. bargaining power of suppliers, 3. bargaining power of buyers, 4. threat of substitute products, spurious items, 5. rivalry among competing firms. • 2. Industry shocks – demand of a product or its cost – weak units will disappear or will be taken over by big units.
Industry level causes of financial distress
• 3. Deregulation – telephone, mobile, courier, airlines, TV, FM broadcasting. • 4. Firm level causes of financial distress: ownership and governance structures, operating risk, leverage. 5. Financial vs economic distress. FD means unable to meet its legal obligations – debt payments. Economic Distress means a fall in operating income or operating income becoming negative.
Effects of financial distress
• 1. Loss of tax benefits of debt and depreciation, 2. Transaction costs, and 3. Agency costs. • Negative liquidity effects: 1. Losing out on professional marketing people. 2. Normal trading activities of shares. 3. Stock exchange may delist shares, 4. Inability to raise equity. 5. Inability to raise debts.
Corporate performance under Financial Distress
• 1.R & D reduction, 2. Advertisementpromotion reduction, 3. Reduction in repairs and maintenance, 4. Incentive schemes are revised. 5. Rationalization of operations and logistics. 6. External credit by vendors. 7. Lay off to workers or reduction in workforce. 8. Downsizing 9. Closing down – decline in PAT, reduction in cost of sales, threat of takeover.
Corporate performance under financial distress
• 10. Sale of assets – increase in value of business. 11. Redeployment of sale proceeds. 12. Equity shareholders vs debt holders - conflicts
Equity holders vs debt holders
• Conflicts: 1. Debt overhand problem / under investment problem. 2. Asset substitution problem – too risky investments. 3. Short sighted plan vs long term plan. 4. Tendency to continue operations, even when liquidation value exceeds operating value.
Minimizing debt holder equity holder problems
• Eliminate debt holder • 1. Protective covenants in scheme – restriction on dividend payout, as a function of earnings. 2. Bank and privately placed debt. 3. Short term vs long term debt – leverage. 4. Use of convertibles – NCD / PCD / Pref. Shares / security designs – redemption, call and put option. 5. Use of project financing. 6. Management compensation contracts.
Financial choices
• 1. Debt restructuring • 2. Investment incentives • 3. Vulture investors – play key role in governance, restructuring and reorganizing firms. They add value by disciplining management. 4. Exchanging equity for debt – to reduce leverage, power of management may go from promoters.
Take over of distressed firm
• 1. Economies of scale. • 2. Market for product can enlarge. • 3. Superior management techniques for control. • 4. Capital contribution to firm. • 5. LBO – Leveraged buy-outs.
Alternatives
• Reorganization or liquidation? • Reorganization: Board of Industrial & Financial Reconstruction (BIFR) will decide after techno economic viability study and discussion with management, banks and financial institutions. Steps: 1.Techno economic viability study, 2. Formulation of plan, 3. Execution of plan, 4. Monitoring activities of the firm.
Reorganization – technoeconomic study
• • • • 1. Management, 2. Production / technology, 3. Finance, 4. Marketing – compare with competitors.
Steps in reorganization
• Steps: 2. Formulation of plan, • 3. Execution of plan – changes from the present in process or method. • 4. Monitoring the rehabilitation plan – proper use of funds, adherence to plan.
Liquidation
• Under section 425 of the Companies Act, 1956. • 1. Compulsory winding up by court?s order • 2. Voluntary winding up by members, or, • 3. Voluntary winding up by creditors, • 4. Voluntary winding up under supervision of court.
Compulsory winding up
• Requirements: 1. Special resolution of shareholders, • 2. Failure to hold statutory meeting, and deliver statutory report, • 3. Commence business within a year, • 4. Reduction of members below 7 or 2. • 5. Inability to pay debts, • 6. Court feels just and equitable.
Liquidation procedure
• Refer to Companies Act, 1956 – sections relating to liquidation and winding up of companies. Also relevant are sections relating to amalgamation and merger, reconstruction and reduction of capital.
Order of priority of distribution of money
• • • • 1. Government dues- taxes, cess, duty. 2. Wages, salaries, 3. Leave encashment, 3. Contribution to ESIC, 5. Compensation under Workmen Compensation Act, 1923. • 6. Dues from Provident Fund / Pension Fund, 7. Expenses of investigation.
Voluntary liquidation
• • • • By members / shareholders (section 489) By creditors(section 499 of Companies Act) By closure application (section 560) Procedure: 1.Statement of affairs is filed with Registrar of Companies. • 2. Liquidator is appointed - notified in gazette. • 3. Proceeds distributed.
Voluntary liquidation
• • • • 4. Final statement of affairs, 5. Liquidation account, 6. Submitted to ROC, 7. Surplus to equity shareholders.
Reorganization in Bankruptcy
• 1. Estimation of future sales, • 2. Analyze operating conditions, so that future earnings & cash-flows are predicted, • 3. Select appropriate capitalization rate, • 4. Apply rate to cash-flow to fix value of firm, 5. Determine capital structure, • 6. Allocate equity, preference shares, debentures, etc. to all claimants, creditors.
Rights of stakeholders
• 1. Equity shareholders control • 2. Equity shareholders have first right to file reorganization plan, • 3. Expensive and time consuming for creditors to develop reorganization plan and get it passed by Court.
Blum Mark
• 12 ratios divided into 3 groups –
– Liquidity ratios – Profitability ratios – Variability ratios He used to predict failure and draw distinction between bankrupt and other firms.
Altman Z score
• Various ratios when used in combination, can have better predictive ability, than when used individually. 22 ratios were considered in combinations, as predictors of failure. He used statistical technique called Multiple Discriminant Analysis(MDA) to distinguish between units. Out of 22, final set of 5 ratios were selected. Weights were given on the basis of significance.
Z score for listed / mfg. firms
• • • • • • Z = 1.2x1+1.4x2+3.3x3+0.6x4+1.0x5 Z= discriminant score X1 = WC / total assets X2 = retained earnings/Total assets X3 = PBIT / total assets X4 = Market value of equity / Book value of debt. X5= sales / total assets
Interpretation of value of Z
• Z= less than 1.81 – likely bankrupt • Z= more than 2.99 – healthy • Z= in the range of 1.81 to 2.99 – area of ignorance.
Z for non-listed / non-mfg. firms
• • • • • • Z= 6.56x1 + 3.25x2 + 1.05x3 + 6.72x4. X4 = book value of equity / total liabilities Interpretation: less than 1.23 – bankruptcy prediction, 1.23 to 2.90 - grey area More than 2.90 – healthy.
J. Argenti Score Board
• Bases on numerical assessment of the firm?s weaknesses / defects, mistakes and symptoms. He has delineated a list of factors to be looked into along-with respective scores. All scores are summed up. Cut off point for healthy firm is 25. Model is criticized for being subjective and arbitrary.
Defects in management
• • • • 8 Chief Executive is an autocrat 4 He is also Chairman 2 Passive BoD – autocrat will see to it. 2 Unbalanced BoD – too many engineers or too many finance persons. • 2 Weak Finance Director • 1 Poor management depth
Defects in management
• 15 poor response to change, old fashioned product, obsolete factory, old directors, outof-date marketing. • 3 no budgets / budgetary control • 3 no cash-flow plan / not updated • 4 no costing system. Cost and contribution of each product not known. • 43 total. Cut off point – 20.
Mistakes
• 15 high leverage • 15 overtrading – expanding faster than funding, small capital base. • 15 big project gone wrong • 45 total. • Pass should be less than 15.
Why MBA students should study this chapter?
• Financial collapse of banks, investment banks and other financial institutions in 2008 could have been identified by financial experts and prevented by proper corrective and preventive measures. All seemed to have ignored to apply these yardsticks to predict bankruptcy. The whole world is suffering for over 2 years with more than 106 banks going bankrupt in USA alone. • One should change employer before it is too late.
Why MBA students should study this chapter?
• If you know how to predict any company or your employer company is tending towards bankruptcy, one or two years in advance, you cam plan change of job or career, before it is too late. Once company is potentially sick, and the world comes to know, any change of job becomes difficult and you lose bargaining power for salary.
doc_587530624.ppt
classify a company sick industrial company, weak unit, sick SSI unit, factors leading to bankruptcy. It explains various factors of bankruptcy, cause and effect of financial distress, effects of financial distress. It also includes J. Argenti Score Board and wilcox model.
FINANCIAL DISTRESS & RESTRUCTURING
• Bankruptcy:Firm is unable to meet its current obligations to the creditors. May occur due to
Dun&Bradstreet Inc. survey) • 1. Economic factors 37.1% • 2. Financial factors 47.3% • 3. Neglect, disorder & fraud 14.0% • 4. Other factors 1.6% • Total 100.00%Sick industrial company
• Sick Industrial Companies Act (Special Provisions) Act, 1985, defines as : • “an Industrial (being registered for not less than 5 years) which has at the end of any financial year, accumulated losses equal to or exceeding its net worth.”
Weak unit
• A non- SSI is weak, if its accumulated losses at the end of accounting year resulted in erosion of 50% or more of its net-worth. • Weak units include SICA units, firms (partnership business), proprietorship concerns. • Weak = potentially sick.
Sick SSI Unit (as per RBI)
• 1. Borrowal accounts has become doubtful advance – principal or interest has remained overdue for more than 2.5 years, and • 2. Erosion of net-worth due to accumulated cash losses to the extent of 50% or mote of its peak net-worth during preceding 2 accounting years. These norms are revised by RBI from time to time. Keep updated.
Update / Amendments
• It was proposed to revise the definition of “sick industrial company” by an amendment through Companies Bill, 2009 introduced in Parliament and awaiting passing of the bill. Thereafter, whenever any financial institution or bank or creditor issues notice to any company for payment of interest or loan, company will be „sick industrial company? after expiry of the notice, if the amount demanded is not paid by company.
Factors leading to bankruptcy
• External: • 1. Change in government policies, 2. Increased competition, 3. Scarcity of raw material, 4. Prolonged power cut, 5. Changes in consumer buying pattern, 6. Shrinking demand, 7. Natural calamities, cost overruns, inadequate funds.
Factors leading to bankruptcy
• • • • • • • Internal: 1. Mismanagement, 2. Fraudulent practices, 3. Misappropriation of funds, 4. Labor unrest, 5. Technical obsolescence, 6. Dispute among promoters.
RBI Survey / Study of Reasons
• • • • • • 1. Mismanagement 2. Faulty initial planning 3. Labor trouble 4. Market recession 5. Other reasons Total 52% 14% 2% 23% 9% 100%
Symptoms - production
• • • • Low capacity utilization High operating cost Failure of production lines Accumulation of finished goods
Symptoms – sales/marketing
• • • • Declining / stagnation in sales Loss of distribution network to competitors Poor quality products Poor aesthetic presentation
Symptoms - finance
• • • • • • 1. High borrowing against assets 2. High borrowing at high interest rates 3. Failure to pay term loans, interest 4. Failure to pay current liabilities 5. Failure to pay salary, wages 6. Failure to make statutory payments.
Symptoms - others
• • • • • • • • 1. Declining market share 2. Attrition of key personnel 3. Persistent cash losses 4. Changes in accounting policies a) deferred revenue expenses, b) longer life of assets, lower depn. c) multiple shift depn./single shift depn. d) repairs and maintenance treated as capex.
Symptoms - others
• Change in accounting years • ( to cover 2 seasons – Navneet Prakashan may change accounting year from 1st April to 30th June to cover 2 seasons)
Prediction of Bankruptcy
• International models: Beaver Model: • Beaver used 30 ratios, classified under 6 categories. He tested these ratios to predict failure of company. Ratio of cash-flow to total debt was the best single predictor of failure. Financial ratios are useful in prediction 5 years prior to the event.
Wilcox Model
• Net liquidation value of a firm, i.e. liquidation value of assets minus liquidation value of liabilities. It is market value of both at a point of time.
Financial distress – issues faced
• 1. Inability to meet debt obligations – temporary cash-flow problem or reduction in asset value than debt + interest. • 2. Temporary cash-flow can be solved by rescheduling creditors. • 3. If asset value is lower, who will bear the losses? In what proportion? 4. Business valuation.
Financial distress – issues faced
• 4. Business valuation, if continued or if closed, to ascertain if found profitable, to continue or to liquidate? • 5. File protection under Chapter 11 of Bankruptcy Act or go for informal procedure or work under directions of Court or BIFR?
Financial distress – issues faced
• 6. To ascertain whether existing management be left in charge or trustee should be appointed – to ascertain controlling force and decide to keep that way or change?
Settlement without going through bankruptcy
• 1. Identify the problem – temporary or not. Like Doctor?s decision to treat a patient as OPD or hospitalization. • 2. Decide informal process or through Court? • 3. Through Court–costs, opposition by creditors, disruptions. • 4. Company with strong fundamentals and good management team with integrity.
Settlement without going through bankruptcy
• Creditors may “workout”something: 1.Extension of time for payment for supplies, 2. Remission of interest, 3.Remission of compound interest, 4. Reduction of interest, 5. Do not invoke bank guarantee, 6. Take equity in place of debt, fully or partly, 7.One-time-settlement(OTS).
Settlement without going through bankruptcy
• • • • • • Creditors’ meeting: Committee of 5 representatives, Creditors? list, amounts due, secured or not, Preferential creditors Government dues Secured creditors and assets charged to those creditors.
Settlement without going through bankruptcy
• 5. Valuation of assets / disposal – payment to creditors in order of priority, surplus to go to common / equity shareholders.
Continued operations
• 1. Improvement in capital equipments • 2. Marketing and logistics • 3. Administration spruce up, management change. • 4. Creditors and bankers are informed. • 5. They cooperate – cost of liquidation can be saved.
Continued operations
• 6. Formal plan is drafted and presented to creditors for composition, extension of new line of credit or help. 7. Talk “win-win” situation. 8. No stigma of bankruptcy on debtor. 9. Simple, cheap, informal process. • 10. Banks agree to restructure than to write down or classify as NPA. 11. Hold out problem – creditors not agreeing to plan.
Informal liquidation
• Value of business is more when closed than when running. • Assignment is possible when firm is small and business is not complex. • Machinery / inventory is in good condition. • Assignment does not result in full and legal discharge of debt.
Cause and effect of financial distress
• Top-down approach: • 1. Macro economic growth, government policies (FDI not allowed in retail, restriction on courier business to protect postal revenue), regulations • 2. Industrial factors, business environment • 3. Macro level factors, liquidity and recession.
Cause & effect of financial distress
• Top-down approach: • 4. Monetary policy and liquidity of nation • 5. Reversal fortune – from diversification to focus – concentrate on core brands and business: i) managerial economies of scale, • ii) economies of scope in production and marketing, iii) financial synergies.
Industry level causes of Financial Distress
• 1.Competition: - 1. barriers to entry, 2. bargaining power of suppliers, 3. bargaining power of buyers, 4. threat of substitute products, spurious items, 5. rivalry among competing firms. • 2. Industry shocks – demand of a product or its cost – weak units will disappear or will be taken over by big units.
Industry level causes of financial distress
• 3. Deregulation – telephone, mobile, courier, airlines, TV, FM broadcasting. • 4. Firm level causes of financial distress: ownership and governance structures, operating risk, leverage. 5. Financial vs economic distress. FD means unable to meet its legal obligations – debt payments. Economic Distress means a fall in operating income or operating income becoming negative.
Effects of financial distress
• 1. Loss of tax benefits of debt and depreciation, 2. Transaction costs, and 3. Agency costs. • Negative liquidity effects: 1. Losing out on professional marketing people. 2. Normal trading activities of shares. 3. Stock exchange may delist shares, 4. Inability to raise equity. 5. Inability to raise debts.
Corporate performance under Financial Distress
• 1.R & D reduction, 2. Advertisementpromotion reduction, 3. Reduction in repairs and maintenance, 4. Incentive schemes are revised. 5. Rationalization of operations and logistics. 6. External credit by vendors. 7. Lay off to workers or reduction in workforce. 8. Downsizing 9. Closing down – decline in PAT, reduction in cost of sales, threat of takeover.
Corporate performance under financial distress
• 10. Sale of assets – increase in value of business. 11. Redeployment of sale proceeds. 12. Equity shareholders vs debt holders - conflicts
Equity holders vs debt holders
• Conflicts: 1. Debt overhand problem / under investment problem. 2. Asset substitution problem – too risky investments. 3. Short sighted plan vs long term plan. 4. Tendency to continue operations, even when liquidation value exceeds operating value.
Minimizing debt holder equity holder problems
• Eliminate debt holder • 1. Protective covenants in scheme – restriction on dividend payout, as a function of earnings. 2. Bank and privately placed debt. 3. Short term vs long term debt – leverage. 4. Use of convertibles – NCD / PCD / Pref. Shares / security designs – redemption, call and put option. 5. Use of project financing. 6. Management compensation contracts.
Financial choices
• 1. Debt restructuring • 2. Investment incentives • 3. Vulture investors – play key role in governance, restructuring and reorganizing firms. They add value by disciplining management. 4. Exchanging equity for debt – to reduce leverage, power of management may go from promoters.
Take over of distressed firm
• 1. Economies of scale. • 2. Market for product can enlarge. • 3. Superior management techniques for control. • 4. Capital contribution to firm. • 5. LBO – Leveraged buy-outs.
Alternatives
• Reorganization or liquidation? • Reorganization: Board of Industrial & Financial Reconstruction (BIFR) will decide after techno economic viability study and discussion with management, banks and financial institutions. Steps: 1.Techno economic viability study, 2. Formulation of plan, 3. Execution of plan, 4. Monitoring activities of the firm.
Reorganization – technoeconomic study
• • • • 1. Management, 2. Production / technology, 3. Finance, 4. Marketing – compare with competitors.
Steps in reorganization
• Steps: 2. Formulation of plan, • 3. Execution of plan – changes from the present in process or method. • 4. Monitoring the rehabilitation plan – proper use of funds, adherence to plan.
Liquidation
• Under section 425 of the Companies Act, 1956. • 1. Compulsory winding up by court?s order • 2. Voluntary winding up by members, or, • 3. Voluntary winding up by creditors, • 4. Voluntary winding up under supervision of court.
Compulsory winding up
• Requirements: 1. Special resolution of shareholders, • 2. Failure to hold statutory meeting, and deliver statutory report, • 3. Commence business within a year, • 4. Reduction of members below 7 or 2. • 5. Inability to pay debts, • 6. Court feels just and equitable.
Liquidation procedure
• Refer to Companies Act, 1956 – sections relating to liquidation and winding up of companies. Also relevant are sections relating to amalgamation and merger, reconstruction and reduction of capital.
Order of priority of distribution of money
• • • • 1. Government dues- taxes, cess, duty. 2. Wages, salaries, 3. Leave encashment, 3. Contribution to ESIC, 5. Compensation under Workmen Compensation Act, 1923. • 6. Dues from Provident Fund / Pension Fund, 7. Expenses of investigation.
Voluntary liquidation
• • • • By members / shareholders (section 489) By creditors(section 499 of Companies Act) By closure application (section 560) Procedure: 1.Statement of affairs is filed with Registrar of Companies. • 2. Liquidator is appointed - notified in gazette. • 3. Proceeds distributed.
Voluntary liquidation
• • • • 4. Final statement of affairs, 5. Liquidation account, 6. Submitted to ROC, 7. Surplus to equity shareholders.
Reorganization in Bankruptcy
• 1. Estimation of future sales, • 2. Analyze operating conditions, so that future earnings & cash-flows are predicted, • 3. Select appropriate capitalization rate, • 4. Apply rate to cash-flow to fix value of firm, 5. Determine capital structure, • 6. Allocate equity, preference shares, debentures, etc. to all claimants, creditors.
Rights of stakeholders
• 1. Equity shareholders control • 2. Equity shareholders have first right to file reorganization plan, • 3. Expensive and time consuming for creditors to develop reorganization plan and get it passed by Court.
Blum Mark
• 12 ratios divided into 3 groups –
– Liquidity ratios – Profitability ratios – Variability ratios He used to predict failure and draw distinction between bankrupt and other firms.
Altman Z score
• Various ratios when used in combination, can have better predictive ability, than when used individually. 22 ratios were considered in combinations, as predictors of failure. He used statistical technique called Multiple Discriminant Analysis(MDA) to distinguish between units. Out of 22, final set of 5 ratios were selected. Weights were given on the basis of significance.
Z score for listed / mfg. firms
• • • • • • Z = 1.2x1+1.4x2+3.3x3+0.6x4+1.0x5 Z= discriminant score X1 = WC / total assets X2 = retained earnings/Total assets X3 = PBIT / total assets X4 = Market value of equity / Book value of debt. X5= sales / total assets
Interpretation of value of Z
• Z= less than 1.81 – likely bankrupt • Z= more than 2.99 – healthy • Z= in the range of 1.81 to 2.99 – area of ignorance.
Z for non-listed / non-mfg. firms
• • • • • • Z= 6.56x1 + 3.25x2 + 1.05x3 + 6.72x4. X4 = book value of equity / total liabilities Interpretation: less than 1.23 – bankruptcy prediction, 1.23 to 2.90 - grey area More than 2.90 – healthy.
J. Argenti Score Board
• Bases on numerical assessment of the firm?s weaknesses / defects, mistakes and symptoms. He has delineated a list of factors to be looked into along-with respective scores. All scores are summed up. Cut off point for healthy firm is 25. Model is criticized for being subjective and arbitrary.
Defects in management
• • • • 8 Chief Executive is an autocrat 4 He is also Chairman 2 Passive BoD – autocrat will see to it. 2 Unbalanced BoD – too many engineers or too many finance persons. • 2 Weak Finance Director • 1 Poor management depth
Defects in management
• 15 poor response to change, old fashioned product, obsolete factory, old directors, outof-date marketing. • 3 no budgets / budgetary control • 3 no cash-flow plan / not updated • 4 no costing system. Cost and contribution of each product not known. • 43 total. Cut off point – 20.
Mistakes
• 15 high leverage • 15 overtrading – expanding faster than funding, small capital base. • 15 big project gone wrong • 45 total. • Pass should be less than 15.
Why MBA students should study this chapter?
• Financial collapse of banks, investment banks and other financial institutions in 2008 could have been identified by financial experts and prevented by proper corrective and preventive measures. All seemed to have ignored to apply these yardsticks to predict bankruptcy. The whole world is suffering for over 2 years with more than 106 banks going bankrupt in USA alone. • One should change employer before it is too late.
Why MBA students should study this chapter?
• If you know how to predict any company or your employer company is tending towards bankruptcy, one or two years in advance, you cam plan change of job or career, before it is too late. Once company is potentially sick, and the world comes to know, any change of job becomes difficult and you lose bargaining power for salary.
doc_587530624.ppt