Friday, December 14, 2007

Industrial sickness : Causes and remedies**

By Ajit Kumar '*'

Sickness in industry is a universal phenomenon .According to one estimate there are five lac sick units in small scale sector and one lac in the medium and large scale sector. Over Rs. 75000 crores of banks and financial institutions funds are locked up in these units.
Sickness is not defined in precise terms in the various Acts. Sickness is a symptom of ailment and not an ailment in itself. Sickness of physical body indicates that some part of the body or the organ is not functioning normal and requires diagnosis. Thus defining sickness in absolute terms has been slightly a tedious job. Defining sickness in industry is still a tough exercise. There has been no standard definition of sickness in industry and probably whatever exists or has been stated as sickness is not definition of sickness but the existence of various parameters which, if present, would indicate that the industrial unit is sick. The financial institutions pay reliance on the· following parameters for the categorisation of the unit in the sick category.
1. Continuous default in repaying the dues of industry.
2. Continuous default in repaying the instalments which have fallen due.

3. Continuous losses.

"Cash-loss" is a fairly acceptable term and stands for the losses before providing depreciation. A unit may not incur cash losses yet it may make default in paying the institutional dues. A unit may be incurring cash losses on a continued basis yet the promoters of the project might be resourceful enough that they might be pumping in additional funds and paying the dues of the institutions in time. The situation thus becomes analogous i.e. a unit which is making cash losses is paying the dues because the promoters are resourceful and a unit which is generating cash accruals is committing default; say due to temporary liquidity problems. Hence the parameters of industrial sickness, as defined above, also do not provide any foolproof yardstick .for measuring sickness.
In this connection reference is invited to the Sick Industries (Special Provisions) Act 1985. As per provisions of the Act a Company may be declared sick if it is registered for seven years; it has accumulated losses which are equal to the net worth of the Company; and if it has incurred cash losses during the financial year in which the reference to Board is made and the year preceding the financial year. Thus the occurrence or cash loss i.e. loss after. deducting depreciation should be for 2 years.
For the purpose of this paper, it is assumed that "Sick Unit" is not a new unit, it has consistently made revenue and cash losses for a number of years, it finds its share capital eroded and needs drastic action to revive it. At the outset it needs to bring out the fact that sickness is not merely a financial phenomenon consisting of losses which can be made good by pumping additional funds to clear all dues. It requires deeper and detailed analysis of the cause which led to the situation.
The Purpose of this article is to know why companies become sick particularly public sector under­takings, what remedial steps should be taken to prevent the chances of companies becoming sick. This paper does not pretend to provide a comprehensive treatment of the subject it raises a few pertinent issues and hopefully provides material for thinking.
Here the fact should not be glossed over that efforts to deal effectively with industrial sickness have so far been largely unsuccessful, is beyond dispute. Only a very small proportion of sick units have been successfully revived.
Sickness concerns the Govern­ment, employees, bankers and others having direct contact with the company. However it is also a national problem in as much as companies which consistently make losses result, inter-alia in:
a. Under utilisation of productive capacity.
b. Lack of product demand.
c. Loss of revenue in various forms of indirect taxes.
d. Over Staffing.
e. Possible loss of exports.
The industrial sickness can be due to many factors such as:-
a. Bad strategy and policy.
b. No diversification, product obsolescence.
c. Company went into new project which was badly conceived.
d. Delays in execution of new
e. Poor organisation and staffing.
f. No modernisation.
g. Old and expensive manufacturing process.
h. Poor Marketing Organisation
1.Inadequate emphasis on
marketing as opposed to selling.
J. Did not change from seller's to buyer's market
k. Lack of any formal Planning, especially financial planning.
1. Wrong Capital Structure
What steps should a company and all concerned with it Government, management and bank should take to revive a sick undertaking. A comprehensive study of the under­taking problems and preparing a composite plan of action must be the starting point of the exercise. Piece­meal and adhoc solutions are rarely adequate. What is needed is a detailed assessment of the comp~ny's existing situation and future prospects covering corporate strategy, Investment, markets, organisation, productivity, labour relations, profitability and finance. An undertaking is ostensibly sick because it is short of working capital and systems have not kept pace with its growth, therefore receiving funds alone will not help. Fortunately, revival is possible in a majority of cases, if timely action is taken and revival programme is implemented with sincerity and commitment.
The old Jute mills and textile mills became sick because they were not modernized, technology were not upgraded. Due to rising costs, the operations of these units became unviable. Eventually, the units became sick. Some of the blue chip companies of today are sick units of yesteryear. Take the case of Goldline. now better known as LG. At one point of time everyone wrote off the company and but thanks to revival efforts of new management LG not only recovered from sickness but grew in a spectacular way. At one stage, Apollo Tyre, Tata Tea HMV etc. were among the sick units. But the Management did not lose heart. They revived them with a clear vision and suitable st(ategies. Unfortunately managements of several undertaking think wrongly that once they get funds, the undertaking can be revived. However, as mentioned in the beginning, providing funds, without attending to the underlying causes of sickness could be throwing money into a bottomless pit. From . the long list of possible causes of sickness it will be apparent that the
single most important cause of sickness is ineffective management. Well managed undertaking can even overcome and deal effectively with difficulties which are due to external factors such as poor demand for the industry's products. Therefore what a sick undertaking needs more than anything else or its revival is a good and stable management. In particular, the undertaking should ensure that it has the full time chief executive. Also the other key posts such as Finance Director and Heads of other functions or division should be properly manned. There is unfortunately inadequate mobility of Managers in our country. Therefore where there are inadequacies in managerial talent attracting good people from outsid~ to a sick undertaking is difficult. However, this is a problem which has to be faced. Some people may be attracted by the challenge which the sick units provide. Management is one area where a sick undertaking should not try to economise. The Board of Directors of Indian Public under­takings are amongst the most ineffective in this area. This is in many cases due to fact that they have part time ex-office Directors nominated by the State or Central Govt. They devote more time te their regular duties and a very little time, if at all, on policy matters of the undertakings. The need for an effective Board is particularly strong when the undertaking is in poor health.
An other important consideration which arises is how does Govern­ment maintain take control over management of undertaking which has been financed largely by it to which several concessions in the form of interest reduction, conver­sion of debt into equity etc. As mentioned above, direct involvement by the Government in the manage- . ment of undertaking is not desirable mainly because they do not have capabilities in industrial manage­ment. Some financial institutions have worked towards building up a pool of senior Managers on their pay­roll who could be assigned to sick undertaking for limited periods of say I to 3 years. This is easy to achieve. Probably the best way to ensure control is through control over equity share holding, constitution of the board and leaving .the actual management to carefully chosen professional managers who are both competent and independent. A sick undertaking like a sick patient needs quick action to restore its health. Every day of delayed action means loss of contribution, increase in cash losses, interest, loss of credibility with suppliers and customers and lowering of staff morale. Once a detailed and comprehensive plan of action has been prepared and viability of the unit established, early action by all concerned is imperative. In practice one finds numerous delays which can be attributed to principal shareholders, Banks, Management, Government and labour.
The delays in obtaining funds from Banks and Financial institutions need particular mention because it is funds that the undertaking needs more than anything else, at least in the short term.
However, the management (including the Board) of undertaking are perhaps even more to blame because they have often not prepared a comprehensive plan of action. Also the boards of directors and Government are found to pay scant attention ·to the manning of top management posts. The banks being business institutions, therefore do not know how precisely they are going to revive the undertaking and improve its ability to repay loans and keep up with interest payments.
When an undertaking becomes sick, several agencies are involved in the revival exercise, Central or State Govt. as the case may be, Board of Directors, Managements, Banks, Financial institutions and labour unions. To get them all to act fast in the interests of the undertaking is not an easy task but it is nevertheless essential to prevent the situation from deteriorating. Skilful financial management during sickness is important and there may be need for reconstruction of capital. The comprehensive study discussed earlier should culminate in short term and long term cash projections and once they are reviewed and accepted, actual performance would need to be carefully monitored. A Financial reorganisation may involve some sacrifices by the creditors and shareholders of the undertaking which can be in several forms:-
1. Reduction of the par value of shares.
2. Reduction in rates of interest.
3. Postponement of maturity of debt.
4. Conversion of debt into equity.
5. Change in the nature of claim or obligation such as from secured to unsecured.
6. Concession by the Government in the form of reduction or waiving of indirect taxes, electricity dues etc.
While sickness among companies in private and public sector has become wide spread, regretfully it is stated that enough research has not been done in developing schemes of financial reconstruction in the Indian environment. Needless to add that the academic and professional institutes could play useful role in this regard.
A great deal more is required to be done to revive sick undertaking than is being done today, in particular one could be more systematic about it and act faster. However, in an extreme case, if viability can not be clearly established, a sick under­taking should be allowed to die peacefully.

*ACMA Former CFM ITI Ltd.

** Published in “The Management Accountant, Student Edition, October, 2003


Priya Mahato said...

Very NYC article...really useful...

Priya Mahato said...

Really useful article

Editor SDJ said...

Thanks for liking the article