Every business faces challenges. These are influenced by not only external factors like the pandemic but also by internal factors such as limited planning, implementation errors, efficiency issues, marketing gaps, and an incompetent and unskilled workforce. Identifying and addressing problems effectively will determine if a business survives or if it will be consigned to the corporate graveyard that history is replete with.
Business sickness
It is considered business sickness when:
- the banking account of the borrower of the enterprise remains as a non-performing asset (NPA) for a period exceeding 90 days or more for either non-payment of principal due or interest, or
- if there is an erosion in the net worth due to accumulated losses to the extent of 50 per cent of net worth, or
- if company financial statements indicate cash losses for two consecutive years.
It is a perfect imbalance in the debt-equity ratio and an alteration in the financial position of the company. The existence of any one of the above-specified conditions, if identified closer to the time of incidence, can significantly increase the chances of recovery.
A symptomatic test that acts as an indicator to identify the stress in the organisation, is the use of the Altman Z score. It is equal to 1.2 A + 1.4 B + 3.3 C + 0.6 D + 1.0 E (A is working capital or total assets, B is retained earnings or total assets, C is earnings before interest and tax or total assets, D is market value of equity or total liabilities, and E is sales or total assets).
A score below 1.8 means, the company is likely headed for bankruptcy, while companies with scores above 3 are unlikely to go bankrupt. Though this is used in the context of the listed companies, one could use an adapted formula to check on the indicators of stress.
One could also spot stress indicators in a company’s financial statements, but there is a need for a more dynamic model.
Dynamic monitoring
Every organisation should constantly monitor its break-even point on a regular basis. It is the level of activity in the organisation where the “sales contribution” equals the fixed costs of the company.
Liquidity is the lifeline of any business which is a function of the speed at which the company can rotate its inventory and receivables or the cash-to-cash cycle. Excessive lock up or increasing number of days of turnover will inevitably lead to choking and creating stress in the system. To create liquidity, the organisation will be forced to increase discounts which would put the margins under pressure and dwindling profitability.
Cost of Quality is a methodology used to define and measure what amount of an organisation’s resources are consumed due to lack of quality and where. In other words, there are four broad categories where these costs start creeping up —internal failures, external failures, appraisal costs, and preventive costs. Only preventive costs are desirable costs, and all other costs are to be minimised. An increase in these is a clear indicator of corporate weakness and the business’s inability to sustain in the medium to long term.
The convergence of technology has amped-up pressure on all businesses, for some more than others. The relevance of products or services and mode of delivery is changing dramatically, and an organisation’s inability to adapt could lead to financial stress. Corporate stress, much like human systems, is part of the lifecycle. The key is to recognise the symptoms early on and work towards resolving them before it gets out of hand.
(The writer is Partner, RVKS and Associates, Chennai)