The term “sickness” is used to describe the phenomenon of the closure of industries and loss of production with the assumption that, if a nursing programme is taken then the industrial unit may be nursed back to health.
In a capital poor economy like ours, we can not afford to have a new unit of the same magnitude. The assumption of the authority is not totally wrong, when we find many industrial units are still continuing their production and operation.
The Government of India tried to nurse many sick undertakings by taking over their management through Industrial (Development and Regulation). Act 1951. In many cases these sick industrial units could not be nursed back to health due to inadequate delegation of authority, bureaucratic control, red tapism, inadequate financial assistance by the government.
Inadequacy of finance may be due to the fact that government simultaneously took many industries under its control and which were considered necessary for social and public interest. However, after 1991, in the economic liberalisation phase government is considering to resell the units or close down units if they are not viable enough.
Let us now see, what is the definition of Industrial sickness. Reserve Bank of India defined sickness as “a unit is considered sick if it has incurred cash losses for one year and, in the judgement of the financing bank, is likely to incur cash losses for the current as well as following year and or there is an imbalance in the unit’s financial structure, that is, when the ratio of current assets to current liabilities is less than 1: 1 and debt equity ratio (total liabilities as a ratio of net worth) is worsening.” Thus an assisted is considered to be sick if it has already incurred losses last year and likely to incur cash losses for another two years and is not in a position to meet the liabilities out of it reserves and capital. There is also mismatch between current assets and current liability.
In the course of its business a sick industrial unit also consumes its net worth. Sudarshan Lai wrote long ago (1979) “a unit can be considered as sick, if it is operating at less than break-even point, that is, where it is unable to meet its cost and depreciation; the unit which has eroded its capital and reserves, should be considered to have reached in advanced stage of sickness.” Both R.B.I.’s definition and above quotation of Sundarshan Lai suggest that in industrial sickness the remedial measures or nursing should be started at the incipient stage of sickness.
The sick companies special provisions Act defines sick company as (a company which is registered for not less than five years) which has at the end of any financial year accumulated loss equal to or exceeding its net worth. Net worth is sum total of paid up capital and free reserves.
Free Reserve = Profit set aside to use in the business – it is part of assets kept readily available to meet other demand.
Current Asset = These Assets are consumed regularly and can be easily converted into cash within a short period. The current assets include cash in hand, cash at bank, debtors stocks, bill receivable, temporary investments, stores, prepaid express.
Liabilities include creditors for goods, bills payable, outstanding expenses, income tax payable, etc.
Current Ratio = Current Asset to Current Liabilities.
Equity Capital = Capital owned by shareholders.
Debt Equity Ratio = This is the ratio obtained by dividing all debt by equity capital, surplus, reserves.
The Sick Companies (Special provision) Act created Board of Industrial and Financial Reconstruction who would judge the viability of a company after a hearing from all parties. If the Board is convinced that the company will run, then it can order a revival package.
If it considers the unit is viable it may also order a merger/amalgamation with other companies. The Board may also order winding up of companies if necessary.
All studies on industrial sickness suggest early detection of sickness for meaningful remedial measure. The Companies Act (Second Amendment) suggests that definition of sickness should include companies which fail to repay its debt for consecutive three quarters to its debtors.
Earlier definitions did not take into account the nature of sickness syndrome at an earlier stage or an incipient stage. For example the definition of sick companies’ special provision Act mentions that a company is to be reported to BIFR (Board of Industrial and Financial Reconstruction) within 60 days of the finalisation of audited accounts if the net worth has been exhausted by 50% or more.
In another level, if erosion of net worth is 50 (fifty) percent or more, the management is required to report the event to the Board for a decision on the company. The Board may decide on merger, amalgamation, rehabilitation or winding up after a fresh appraisal through an operating agency. (Operating agency is here any bank or financial institution). It has been seen, when a company faces 50 percent reduction of net worth means that the company is already facing a “terminal illness.” So early detection is necessary for the revival of the company. Thus approach of Sick Companies Act is only inviting dilly-dally and procrastination. Omkar Goswami Committee Report was highly relevant, when they suggested early remedial measure.