MANAGING BANKRUPTCY

Decision goes wrong

What happens ?

Which Direction to go?

Bankruptcy
What is Bankruptcy ? A firm is said to be Bankrupt if it unable to meet its current obligation to the creditors . It may occur on account of both Internal and External Factors. As also gross mismanagement. The Companies are first declared sick and for this each has a definition which goes with the type of the company A sick Industrial company is one which is registered for not less than 5 years and has accumulated losses equal to or exceeding its entire NW. Similarly a SSI unit is classified sick if A) any of its borrowal accounts have become doubtful and B) there is erosion of NW due to accumulated cash losses to extent of 50 % or more its peak NW during the preceding 2 accounting years

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FACTORS LEADING TO BANKRUPTCY External factors - Increased competition - Shrinking demand - Cost overruns - Inadequate fund mobilization - Natural calamities - Changes in consumer pattern of buying - Prolonged power cuts and - Scarcity of raw material - Change in government policies affecting the firm.

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Mismanagement

Labor unrest

Internal Factors Disputes Among Promoters Obsolete Machinery and Production techniques

Fraudulent practices and appropriation of Funds by the Management

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Symptoms of Bankruptcy: Persistent cash losses over the years Increased borrowing against assets Accumulation of finished goods, and declining or stagnant sales Failure in production lines Failure to meet fixed and current liabilities Failure to pay salaries in time Failure to meet taxes Loss of distribution network to competitors Decline in the ratios over the years to unacceptable levels, High operating costs Low capacity utilization Fall in Share price Rapid turnover of key personnel Improper investments Govt .policy

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Bankruptcy costs The Bankruptcy has costs involved which are -Direct which is legal, accounting, filing and other administrative costs -Indirect which are lost profits that a firm can be expected to suffer ex. Loss on account of sales of assets below the economic inefficiencies. Bankruptcy drains out the cash in the system to suppliers of capital Threatens employees, suppliers and also customers So How to reduce the probability of Bankruptcy is by maintaining adequate liquidity Therefore we have to maintain adequate liquidity at all times. There is also a cost for maintaining liquidity which is called liquidity cost. This liquidity cost is arrived at by the following LC = I ( interest earned ) C ( Cost of financing)

Contd Can we predict Bankruptcy and failure of the firm ? Yes the symptoms have already been discussed earlier . However, can there be some way to technically analyse these warning signals. Yes There are some International models for the prediction which include - The Wilcox model - Blum Marcs Failing company model - Beaver model - Altmans Z score model Apart from above we have L.C.Gupta model which is the Indian model. The two models of Altmans Z score model and L.C.Gupta Model are important and relevant.

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Altmans Z Score Model The model uses Ratio analysis to predict the failure These ratios are used in combinations. Initially he took 22 ratios and ultimately sliced down to 5 ratios by comparing between bankrupt and non bankrupt firms for his analysis Altman Gave weights to these 5 ratios on the basis of their significance to predict the health of the model and used the statistical technique called the Multiple Discriminant Analysis (MDA) to distinguish. This discriminant score was called Z score. The variables used are X1 return on assets, measured by EBIT / TA X2-Stability of earnings X3- Debt service by Interest coverage ratio I.e. EBIT / Total Int Payments X4- Cumulative profitability Retained Earnings / TA X5 Liquidity Current Ratio X6 Capitalization Common equity / Total Capital X7 Size measured by the firms TA

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LC Gupta ModelHere 56 Ratios was used to determine the best set of ratios to predict failure which were categorised as Profitability and Balance sheet ratios.

Ratios used were Profitability Ratios - EBDIT / Net sales - OCF / Sales ( Operating cash flow / sales) - EBDIT / (TA + Accumulated depreciation) - OCF / TA - EBDIT / ( Interest + 0.25 Debt) Balance sheet ratios - NW / Total Debt - All outside liabilities / Tangible assets

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How does Banks Asses the Weakness in the firm ? - Regular overdrawing over and above the limit I.e. excess over the limit - Irregular submission of stock statements - Old depleted stock or non moving items of stock - Not keeping commitments of the bank - Increasing creditors / Debtors over the period of years - Increasing in unsecured loans - Non compliance of the terms of sanction - Increase in overheads of the organisation - Too frequent seeking of enhancement in credit limits - Dishonour of bills of trade - Too frequent dishonor of cheques - Failure to honor the forward contracts in export trade - Depletion of capital by way of loans, drawings etc. - Too frequent changes in the management - Non submission of financial data in time and renewal of limits in time - Overtrading

Contd.. In such cases were imminent bankruptcy is being faced or weakening of the firm what are the alternatives to the firm ? 1. Reorganization by a) Techno economic viability study and b) Formulation and execution of a planned monitoring of the activities of the firm. 2. Compulsory winding up 3. Voluntary Liquidation ( Section 489 Members voluntary winding up) and Sec 499 ( Creditors winding up) 4. Restructuring by means of Mergers and Acquisitions 5. Leverage restructuring by massive changes in the form of leveraged recapitalization or leveraged buy outs. Also called LBO I.e. leveraged management buy outs . Here the subordinated debt plays an important role 6. Auctioning

Contd.. There are other methods to assist the sick units before it is declared bankrupt which includes - BIFR The units can be assessed for the rehabilitation of the sickness. The unit will be referred and financial assistance by way of further funding can be given to cover the sickness. - Here the existing overdues and the outstandings are regrouped and fresh repayment schedule is drawn up based on the expected cash flows. - The viability of the project for restructure is valued on an existing value of the assets and cash generation of the unit is studied . - A time lag is given for the unit to start internal accruals and accordingly the repayment is rescheduled. - Interest component upto the date of rehabilitation if bundled up as a separate loan component for purposes of clarity. - However, once Rehabilitated, the monitoring is done on a strict basis so that no fresh slippages are allowed and the unit is picked up.

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