Ch 38 Industrial Sickness

Presenter:
Prof. Isha Dave

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
units financial structure, i.e. current ratio is less
than 1 & debt-equity ratio is worsening.
Compiled by: Prof. Rajsee Joshi

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

Compiled by: Prof. Rajsee Joshi

Causes of Sickness
2. Managerial deficiencies
Deficiencies in Production
Deficiencies in Marketing
Deficiencies in Finance
Deficiencies in Personnel

Compiled by: Prof. Rajsee Joshi

RBI Study of Causes of

Sickness

Study covered 378 units, on the causes of

industrial sickness revealed the following

picture:
Number Percenta
ge
Mismanagement and managerial
deficiencies

197

52

52

14

Market recession

86

23

Others (infrastructural factors, raw

material shortage, etc.

34

100

100

Faulty initial planning and other

technical drawbacks
Labour trouble

Total
Compiled by: Prof. Rajsee Joshi

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
Compiled by: Prof. Rajsee Joshi

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
Compiled by: Prof. Rajsee Joshi

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.
Altmans 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
Compiled by: Prof. Rajsee Joshi

Altmans 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

Compiled by: Prof. Rajsee Joshi

Revival of a Sick Unit

Step 1. Viability Study:
Market Analysis
Production/Technical Analysis
Financial Analysis
Personnel Organization
Environment

Compiled by: Prof. Rajsee Joshi

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
Compiled by: Prof. Rajsee Joshi

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

Compiled by: Prof. Rajsee Joshi

Turnaround Stories
TVS Suzuki
Started its operations in 1997-98
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
Compiled by: Prof. Rajsee Joshi

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
Compiled by: Prof. Rajsee Joshi

Thank You

Compiled by: Prof. Rajsee Joshi