FINANCIAL DISTRESS INDICATORS ACC302

Sample Project Study Report

MODULE: FINANCIAL LITERACY FOR DIRECTORS

TITLE OF STUDY: FINANCIAL DISTRESS INDICATORS

CONTENTS

Project Objectives & Goal............................................................................................................................................................... 3

Introduction & Context.................................................................................................................................................................... 5

Useful KPIs.................................................................................................................................................................................... 5

Case study of Videocon.............................................................................................................................................................. 8

BPL............................................................................................................................................................................................... 14

Project Scope How Its implementation will help the organization.................................................................................... 19

The Project Specific details of the project and its implementation strategy.................................................................... 20

Conclusion Key Findings & Recommendations...................................................................................................................... 21

Acknowledgements....................................................................................................................................................................... 21

PROJECT OBJECTIVES & GOAL

Financial Indicators are tools for measuring and tracking progress in essential areas of company performance. Key performance indicators (KPIs) provide a general picture of the overall health of a business. Acquiring insights using key metrics allows organizations to be proactive in making necessary changes in underperforming areas, preventing potentially serious losses.

The metric quantification then allows measure of the effectiveness of an organizations efforts. A fixed process ensures the long-term sustainability of a company's operating model, and helps increase the business's value as an investment.

The first priority is to identify and understand the overall impact that the various financial realities represented by the KPI numbers have on a business. Then, the insights acquired from these invaluable financial management performance indicators should be used to identify and implement changes that correct problems with policies, processes, personnel, or products that are impacting one or more of your KPI values.

Primary KPIs that are almost unanimously used include revenue, expense, gross profit, and net profit. Some other key indicators that should be tracked, analyzed, and acted upon are identified in this project study report.

In recent times, numerous companies have been faced with insolvency and bankruptcy. In India, the IBC code (Insolvency & Bankruptcy) was formalized in 2016 aiming to consolidate the existing frameworks by creating a single law for insolvency and bankruptcy. Bankruptcy is a state of insolvency wherein the company or the person is not able to repay the creditors the debt amount.

Bankruptcy prediction is of importance to the various stakeholders of the company as well as the society on the whole. Early identifiers of insolvency or bankruptcy are vital and very pertinent. A company that is currently going through IBC will be presented in this project report to bring how various metrics indicate or help in predicting bankruptcy.

Further, to bring about a comparison, a peer company from the same sector will be analyzed to look at sectoral trends and any macro or external factors influencing the performance of the companies.

As a conclusion, two recommendations will be made generic metrics that should be monitored by directors of any company and specific recommendations for a fictitious company.

Summary Of This Project Study Report

1. Useful KPIs

1. Advance indicators of bankruptcy or insolvency

1. A case study of the KPIs of a company currently in insolvency Videocon Industries

1. Review of a competitor of Videocon Industries - BPL

1. Observations from the perspective of a board member of BPL

1. Recommendations to the executives of BPL

Goal

The goal of this project study report for me (Author: Abhinav Mathur) is to:

1. Understand the KPIs to be tracked by every company keeping a keen lookout for early indicators of insolvency and bankruptcy

1. Evaluate the metrics, first hand, using two companies to gain practical exposure and to simulate a real life board

1. Objectively make recommendations to the board or executives of one of the companies to simulate a real life board scenario.

Achieving these three goals will enable me to function effectively in a board room as an Independent Director or a Non-Executive Director in the future.

INTRODUCTION & CONTEXT

USEFUL KPIS

As a board member or Independent Director, it is imperative to be aware of the various KPIs. As an engineer, I was not aware of these KPIs which are fairly basic and commonplace in financial texts.

1. Operating cash flow

Monitoring and analyzing the Operating Cash Flow is essential for understanding the ability to pay for deliveries and routine operating expenses. This KPI is also used in comparison with total capital in usean analysis that reveals whether or not the operations are generating sufficient cash for support of capital investments being made to advance the business.

The analysis of the ratio of operating cash flow compared to the total capital employed gives deeper insight the business's financial health, allowing insight beyond just profits, when making capital investment decisions.

2. Working Capital

Cash that is immediately available is "working capital". Cash on hand, accounts receivable, short-term investments are all included, as well as accounts payable, accrued expenses, and loans are all part of this KPI equation.

This especially meaningful KPI informs of the condition of the business in terms of its available operating funds, by showing the extent to which the available assets can cover the short-term financial liabilities.

3. Current Ratio

While the Working Capital KPI discussed above subtracts liabilities from assets, the Current Ratio KPI divides total assets by liabilities to give an understanding the solvency of the businessi.e., how well the company is positioned to meet its financial obligations consistently on time and to maintain a level of credit rating that is required to order to grow and expand the business.

4. Debt to Equity Ratio

Debt to Equity is a ratio calculated by looking at the business's total liabilities in contrast to the shareholders' equity (net worth). This KPI indicates how well the business is funding its growth and how well it is utilizing the shareholders' investments. The number indicates how profitable the business is. It tells how much debt the business has accrued in effort to become profitable. A high debt-to-equity ratio reveals a practice of paying for growth by accumulating debt. This critical KPI helps you focus on the financial accountability.

5. Accounts Payable Turnover

The Accounts Payable Turnover KPI shows the rate at which the business pays off suppliers. The ratio is the result of dividing the total costs of sales during a period (the costs the company incurred while supplying its goods or services), by the average accounts payable for that period.

This is a very informative ratio when compared over multiple periods. A declining accounts payable turnover KPI may indicate that the length of time the company is taking to pay off its suppliers is increasing and that action is required in order to keep a good standing with vendors, and to enable the business to take advantage of significant time-driven discounts from vendors.

6. Accounts Receivable Turnover

The accounts receivable turnover KPI reflects the rate at which the business is successfully collecting payments due from customers. This KPI is calculated by dividing total sales for a period by the average accounts receivable for that period. This number can serve as an alert that corrections need to be made in managing receivables, in order to bring payment collections within appropriate timeframes.

7. Inventory Turnover

Inventory continuously flows in and out of production and warehousing facilities. It can be hard to visualize the amount of turnover that is actually taking place. The inventory turnover KPI allows insight into how much of average inventory the company has sold in a period. This KPI is calculated by dividing sales within a given period by your average inventory in the same period. The KPI gives a picture of the company's sales strength and production efficiency.

8. Return on Equity

The Return on Equity (ROE) KPI measures the company's net income in contrast to each unit of shareholder equity (net worth). By comparing the company's net income to its overall wealth, the ROE indicates whether or not net income is appropriate for the company's size.

Regardless of how much the company is currently worth (its net worth), the current net income will determine its probable worth in the future. Therefore, the business's ROE ratio both informs the amount of the organizations profitability and quantifies its general operational and financial management efficiency. An improving, or high ROE clearly indicates to shareholders that their investments are being optimized to grow the business.

9. Quick Ratio

The Quick Ratio KPI measures the organization's ability to utilize its highly liquid assets to immediately meet the business's short-term financial responsibilities. This is the measurement of the companys wealth and financial flexibility. It is understood as a more conservative evaluation of a business's fiscal health than the Current Ratio, because calculation of the Quick Ratio excludes inventories from assets.

This Quick Ratio KPI has the popular nickname of "Acid Test. Similarly, the Quick Ratio is a quick and easy way of assessing the wealth and health of a company.

10. Additional Key Indicators

Certain other KPIs should be tracked in specific operational areas of finance, marketing, production, purchasing, customer services, and others. For examples:

Marketing KPIs Cost Ratio of Customer Acquisition to Lifetime Value, Lifetime Value, Customer Acquisition Cost, and others, Customer Profitability Score, Relative Market Share.

Recurring Revenue Metrics income and expense areas, such as recurring service contract fees, subscription fees, product maintenance fees, Revenue Growth Rate, Cash Conversion Cycle.

Recurring Revenue Overview include Recurring Revenue Proportion, Recurring Revenue Growth Rate, Recurring Revenue Exit Rate.

LOB Efficiency Measure Operating Cycle Time (production rate), Capacity Utilization Rate, Process Downtime Level, Human Capital Value Added, Employee Engagement Level, Quality Index.

Finance Department Operational KPIs should also include obscure indicators such as Finance Error Report KPI, Payment Error Rate KPI. And, a variety of indicators in areas of billing and transaction management, collections, and others.

Altman Z Score The Altman Z Score is used to predict the likelihood that a business will go bankrupt within the next two years. The formula is based on information found in the income statement and balance sheet of an organization

When Z is >= 3.0, the firm is most likely safe based on the financial data.

When Z is 2.7 to 3.0, the company is probably safe from bankruptcy, but this is in the grey area and caution should be taken.

When Z is 1.8 to 2.7, the company is likely to be bankrupt within 2 years. When Z is <= 1.8, the company is highly likely to be bankrupt.

Note: KPI failures can occur due to any one of a number of reasons

Usually, the most readily identifiable are insufficiencies in planning, or human error.

Customizing a KPI without thoroughly vetting it for its actual practical value to the business can lead to problematic results. Such a KPI can distract from focusing on true indicators of performance, and can send a business in the wrong direction.

Misusing KPIs can happen by over-emphasizing the KPI number itself, and under- emphasizing the real-world operational contributors that generate the numbers. This syndrome can lead to unclearly focused business strategies for improving the parts of operations that underlie the numbers.

CASE STUDY OF VIDEOCON

Videocon Industries was admitted by the National Company Law Tribunal (NCLT) for insolvency proceedings in June 2018.

In three consecutive financial years until September 2008, Videocon's India business had registered standalone profits of over Rs800 crore with a focused approach in the consumer electronics business.

Videocon's debt surged because of its failed telecom services business - it lost about Rs 7,000 crore in telecom - and the picture tube plant modernization in Gujarat that cost Rs 4,000 crore. Meanwhile, the flagship consumer durables business also slowed down due to competition against global rivals like LG and Samsung. Over time, the market value of the fridge-to-phone company tumbled way down to Rs 600 crore. The decline started with Dena Bank classifying its Rs 520 crore loan to Videocon as an NPA in the quarter ending March 2017. The stock lost 42 per cent in the next three trading days.

This debt was accumulated over time as Videocon expanded into oil and gas, telecommunications, and direct-to-home (DTH) TV. However, its main business of electronic appliances is struggling to make the money required to service the debt, and the new ventures havent shown tremendous promise. The Videocon case is classic of companies aggressively borrowing to expand but failing to repay. Videocon is among the most-leveraged groups in Asias third-largest economy. In fact, a Credit Suisse study in October 2015 named it among the 10 groups with the highest debt in India. Several experts, had repeatedly voiced their concerns about the ticking time bomb of corporate debt in India. These high borrowings often translate into toxic assets for banks.

Since 2007, Videocons debt has shot up by seven times. And thats not all. The groups interest paying capacity has deteriorated during the same time. Its interest coverage ratio, the ratio of operating profit to the interest payable, is below one. This means it doesnt generate enough funds that can cover its annual interest payments.

Some 85% of its revenue comes from its consumer electronics business. In 2016, this segment saw a 15% drop in income. The Indian appliance and consumer electronics industry, estimated to reach $20.6 billion by 2020, has lately seen weak growth. Mounting input costs are squeezing margins even though demand is growing. The industry has also seen a shift from off-line to online shopping. Meanwhile, Videocons crude oil and natural gas venture saw revenues dip by 39% mostly due to a glut in global oil prices.

The group is now trying hard to trim debt. For one, it is selling off assets, something most leveraged Indian groups with their backs to the wall do. It has also monetized other assets like spectrum, besides merging its DTH service with Dish TV.

Videocon Industries

Having seen the financial status of Videocon Industries, which has already been admitted under IBC, let us now look at another peer company in the consumer electronics space to evaluate the current standing and predict its future using indicators.

BPL

BPL is an Indian electronics company. From 1980 onwards, when the industrial licensing was relaxed, BPL began manufacturing televisions and telecommunications equipment, demonstrating its potential and future business area. It began collaborating with the Japanese Sanyo Electric Company in the early 1980s with a technology-transfer agreement In the early 1990s, after globalization and liberalization of the Indian economy, competition entered the market. BPL retained its strong presence and growth rate.

During the late 1990s, the company's annual revenue peaked at ?4,300 crore (equivalent to ?140 billion or US$1.9 billion in 2017).

BPL concentrated on importing technology, improving product quality, innovations and manufacturing of electronic products. In late 1980s, BPL had metamorphosed from an entrepreneurial venture, into India's biggest consumer electronics & telecommunication company.

Following economic liberalisation in India in 1991, BPL faced increased competition from South Korean companies LG and Samsung.[2] Internal disputes within the controlling family took away attention from external threats, and the company's fortunes declined.[2] By 2004, BPL and Sanyo were facing serious financial problems due to intense competition in the global electronics market.[4] In 2005, the companies announced a joint-venture, and BPL transferred its colour television business, then worth US$80 million, to the new venture.

BPL was restructured with a focus on energy, healthcare, consumer electronics and home security systems.

BPL Ltd has reported a net loss of ?34.76 crore (equivalent to ?79 crore or US$11 million in 2017) in the second quarter of fiscal 2005-06, on gross sales of ?34.71 crore (equivalent to ?79 crore or US$11 million in 2017). Operating losses were at ?13.91 crore (equivalent to ?32 crore or US$4.4 million in 2017).

Gross sales were ?64.45 crore (equivalent to ?156 crore or US$22 million in 2017) in the corresponding period during 2004-05 while net loss was at ?41.59 crore (equivalent to ?101 crore or US$14 million in 2017).

According to the company, the promoters have brought in ?50.08 crore (equivalent to ?121 crore or US$17 million in 2017) as contemplated in the corporate debt restructuring scheme. The amount was to pay statutory liabilities, unsecured, pressing creditors, dealers, credit balances, employee dues and working capital requirements, in part.

In respect to the auditors' qualification of the company's accounts for the period ended 31 March 2005, about undisputed amounts payable in respect of income-tax (?4.44 crore (equivalent to ?11 crore or US$1.5 million in 2017)), dividend tax (?2.51 crore (equivalent to ?6.1 crore or US$840,000 in 2017)), wealth tax (?0.11 crore (equivalent to ?2.7 million or US$37,000 in 2017)), TDS (?6.77 crore (equivalent to ?16 crore or US$2.3 million in 2017)) and customs duty (?1.68 crore (equivalent to ?4.1 crore or US$570,000 in 2017)).

The balance in customs duty would be paid once the financial restructuring is completed and normalcy of operations is achieved, according to the company.

Comparison with peers

Altman Z score for BPL : 1.20

PROJECT SCOPE HOW ITS IMPLEMENTATION WILL HELP THE ORGANIZATION

After evaluating the various parameters of BPL, these are the recommendations based on the data available in the public.

1. Corporate Governance

1. Product Committee

1. Market insights committee

1. Strategic Alliances

1. M&A

BPL has shown some signs of revival, but unfortunately they have not been consistent at it. It is a very topsy-turvy revival. It indicates that some of the steps being taken are working while some are lacking. As a board member or an independent director, it is expected to make recommendations for the overall health of the company.

I recommend the constitution or emphasis on the above committees to pave the path for the company in the future. The company should be looking either to continue working independently, shut down or get acquired. The role and objective of each committee is described in the next section.

THE PROJECT SPECIFIC DETAILS OF THE PROJECT AND ITS IMPLEMENTATION STRATEGY

The project will be to constitute 5 committees to perform specific short term and long term objectives.

• Corporate Financial Governance

Objective: To identify and own and personally drive financial governance KPIs within the company.

Constitution: 5 member team

3 key financial employees of the company

1 external member from a financial audit firm on consultation basis

1 external member from the industry as a financial consultant

Short term goal:

The committee to be formulated within 60 days from the approval in the board meeting and/or AGM. The committee to complete identification of the key KPIs to be tracked. The committee to segregate and assign the key KPIs to the 3 employees of the company.

Long term goal:

The committee to make strategic recommendations once every month over the course of two years on the basis of tracking the KPIs. If any KPI is being impacted or on course to underperform, they need to highlight it along with make recommendations for corrective action.

My observations:

• Product Committee

Objective: To identify new products that can be launched by BPL

Constitution: 3 member Product Research Team Short term goal:

In a competitive consumer electronics space, product innovation happens at lightning pace. The goal of this team is to identify in 60 days, 50 new products that the company may want to sell. After identification, the next stage will be to critically evaluate the feasibility of all of them and if they should proceed with it.

Long term goal:

To work with the market insights team to identify the available market for the 50 products. To Look at the competition and see if there is possibility of entering the market with the product. To look internally if there is sufficient competence and know how to make the product in-house. If not, work with the strategic alliances team to investigate a buy/partner scenario.

At the end of 90 days, the committee to have a recommendation for new products and all data to back up the recommendation.

3. Market insights committee

Objective: To keep a keen eye on the consumer electronics market and competitive landscape

Constitution: 1 member team

Short term goal:

To create a competitive landscape for existing product portfolio within 15 days. To help create competitive landscape for all the 50 products that the product team has identified and then subsequently narrowed down.

Long term goal:

To alert the executive and board members about any significant changes in the market landscape or major trends in the industry. Also keep track of the competitors and alert if any major activity for the competitors.

• Strategic Alliances

Objective: To create strategic alliances for rapid and accelerated product go-to-market.

Constitution: 2 member Strategic Alliances team

Short term goal:

To create strategic alliances for technology, distribution, marketing and post-sales support for existing and new products. Identify partners and strategic alliances candidates in 30 days.

Long term goal:

To work with product team, market insights team to create concrete alliances within 3 months in all aspects of technology, distribution, marketing and post-sales.

5. M&A

Objective: To actively drive for an exit via M&A or company closure

Constitution: 2 member M&A team

Short term goal:

To scout for possible acquirers of the company for an exit. To work with valuation firms to arrive at a valuation for the company

Long term goal:

To work with potential buyers, boards and executives of multiple companies for a possible acquisition or merger. If a merger is not happening, then make a recommendation for a shutdown of the company.

CONCLUSION KEY FINDINGS & RECOMMENDATIONS

The consumer electronics space is a very fast moving space. New products and trends emerge very rapidly and a company with a target market of 1.2billion Indians has to move very quickly to capitalize on the next trend or wave of technological advances. If you look at televisions, televisions have evolved from CRT to LCD to LED to HD to 4kHD. Similarly, audio equipment has evolved very rapidly. The virtue of any consumer electronics company is speed. If BPL has to survive, they have to move swiftly. To be re-instated as a market leader, they have to get globally competitive products to the consumers. Indian consumers can no longer be given half-baked or sub- standard products. With a laser focus on financial health and key metrics, the turnaround is possible and BPL can thrive in the market in the future.

ACKNOWLEDGEMENTS

1. com

1. Dion Global Solutions Limited

1. in

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