The sick industrial companies (special provision) act 1985, defined sickness in terms of “cash losses for two consecutive financial years and accumulated loses equaling or exceeding the net worth of the company at the end of the second financial year”.
The problem of industrial sickness is nothing peculiar to our economy or any developing country. It is also present in the advanced countries, hut there it is considered prudent to shut down the units if they are sick.
But in developing countries, like India, one cannot afford to do so as it will lead to substantial block of national capital to go waste and create unemployment of those already employed, when additional employment is a crying need of the hour.
Even ‘not so fit’ or ‘unfit’ industries may have to be rendered a helping hand to raise and stand on their own, to avoid wastage or total loss of funds and other resources already invested therein.
1. Introduction to Industrial Sickness 2. Definitions of Industrial Sickness 3. Nature 4. Concept 5. Stages 6. Signal
7. Symptoms 8. Causes 9. Criteria to Identify Sickness 10. Magnitude 11. Reasons and Their Consequences 12. Prevention.
Industrial Sickness: Definitions, Nature, Concept, Stages, Symptoms, Causes, Magnitude, Reasons, Consequences and Prevention
- Introduction to Industrial Sickness
- Definitions of Industrial Sickness
- Nature of Industrial Sickness
- Concept of Industrial Sickness
- Stages of Sickness in an Industrial Unit
- Signal of Industrial Sickness
- Symptoms of Industrial Sickness
- Causes of Sickness in Units
- Criteria to Identify Sickness/Incipient Sickness
- Magnitude of Industrial Sickness
- Reasons and Their Consequences of Industrial Sickness
- Consequences of Industrial Sickness
- Prevention of Industrial Sickness
Industrial Sickness – Introduction
Problem of industrial sickness is not specific to any industry or country. The approach to sickness is to restore a unit to normalcy through restructuring devices within a short period of time or else close it down. Such easy and straight forward options are not available to labour abundant economies like India which can ill afford large scale unemployment either of labour or of valuable productive assets caused by sickness.
Further, sizeable funds of banks and financial institutions and blocked up in sick units which impair the banks profitably and their ability to recycle fund in other productive areas. This has an adverse effect on the economy of country like India. Thus, industrial sickness is a result of faulty management policies as well as fiscal problems. Under such circumstances, fiscal reforms programme with a determined management and relevant management policies for revival of sick industries are need of the hour.
“Industrial development is identified as the effective means to the economic growth in any country. Industrial sickness has become a common feature of the large scale sector as well as small scale sector. In spite of the enactment of special legislations and various steps taken by the government and RBI to deal with the problem, industrial sickness is growing. The liberalization of the economy resulting into increased competition has added to the problem of industrial sickness.” “Closures of business units and corporate failures resulting in bankruptcies have become a normal feature in market economies the world over”.
Growing competition and the ever-changing international economic environment often lead to high incidence of corporate failures in developed market economies. However, these economies have the resilience to absorb the economic disturbances brought about by the closure of industrial units. In order to combat the problem of industrial sickness, a comprehensive assessment of the magnitude of industrial sickness and an analysis of the main factors which bring about sickness are necessary.
Both prevention and cure of industrial sickness would depend on our ability to identify sickness as early as possible and analyze its causes. Faulty or delayed identification would reduce the effectiveness of the remedial action such as restoring the financial viability of sick units and protecting units which would become sick.
The problem of industrial sickness is nothing peculiar to our economy or any developing country. It is also present in the advanced countries, hut there it is considered prudent to shut down the units if they are sick. But in developing countries, like India, one cannot afford to do so as it will lead to substantial block of national capital to go waste and create unemployment of those already employed, when additional employment is a crying need of the hour. Even ‘not so fit’ or ‘unfit’ industries may have to be rendered a helping hand to raise and stand on their own, to avoid wastage or total loss of funds and other resources already invested therein.
Industrial Sickness – Definitions
In general a sick unit can be defined as a unit that fails to generate surplus on a continuous basis and frequently depend on external funds for its survival.
According to the Reserve Bank of India (RBI) a small scale unit is considered as a sick unit if it has “incurred cash loss in the previous accounting year and is likely to continue to incur cash loss in the current accounting year and has on erosion on account of cumulative cash losses to the extent of 50 percent of those of its net worth”.
According to ICICI, a sick industry is one whose financial viability is threatened by adverse factors present and continuing. The adverse factor might relate to management, market fiscal burden, labour relations or any other. When the impact of factors reaches a point where a company begins to, incurred cash losses leading to erosion of its funds, there is threat to its financial stability.
The sick industrial companies (special provision) act 1985, defined sickness in terms of “cash losses for two consecutive financial years and accumulated loses equaling or exceeding the net worth of the company at the end of the second financial year”.
The definition of sick small scale industry has been modified as, “A small scale, industrial unit should be considered as sick if it has, at the end of any accounting year, accumulated losses equal to or exceeding 50 percent of its peak – net Worth in „the immediately preceding five accounting years”
Various studies were conducted to determine the causes of sickness in small scale industry.
The brief review of the study is as follows:
1. In 1975 the study team of State Bank of India, stated lack of management expertise and lack of adoption of sound business principles in running the enterprise are the important factors that lead to extensive sickness in small scale industry.
2. The 1988, FICCI survey stated, in sufficient or delayed receipt of working capital and heavy dependence on other sources of finance and the inability to spend on advertisement and salesmanship are the reasons for sickness in small scale industry.
3. U.K. Mazumandar and A. Nag of Indian institute of economics, conducted a survey and revealed that lack of finance to meet working capital needs and non-availability of raw materials are the principal reasons for sickness.
4. Andhra Pradesh state financial corporation conducted a study and observed that the problem of finance, production and marketing have been equally contributing towards the sickness of small scale industry.
5. The Haryana unit of the All India Federation of the small and rural industries said, the basic factor responsible for sickness of small units was delayed payment by the principals for more than four months.
Industrial Sickness – Concept
The recent RBI guidelines facilitate the detection of sickness at the incipient stage but only for large and medium units.
An industrial unit will be termed as “weak,” if at the end of any accounting year it has:
(i) Accumulated losses equal to or exceeding 50 per cent of its peak net worth in the immediately preceding five accounting years,
(ii) A current ratio of less than 1:1,
(iii) Suffered a cash loss in the immediately preceding accounting year.
If the downfall in the smooth functioning of various operational areas of the unit continues unabated. The actual process of sickness then starts.
Such a stage is considered to be incipient sickness and is identified by reference to the following symptoms:
(1) There are continuous such losses from year to year and the trend is expected to continue in future.
(2) Deterioration is expected in the current ratio in the current financial year, even though the same may have been more than one in the previous financial year.
(3) There is gradual erosion in the net worth during the previous and current financial year and is expected to continue in future also.
(4) Deterioration continues in the debt-equity position in the current financial year and subsequently also.
In a nutshell, it may be seen that incipient industrial sickness is that stage where the unit incurs cash losses; however the position of financial structure may not be very much alarming. This is the time to take certain corrective measures to prevent the unit from turning into sickness. This will, however, require proper identification, care and follow-up programme.
According to Section 3(0) of the Sick Industrial Companies (Special Provisions) Act, 1985, a sick industrial company is an industrial company (being a company registered for not less than 5 years) which has at the end of any financial year accumulated losses equal to or exceeding its entire net worth. The condition of 7 years have reduced to 5 years and the condition regarding cash losses has been omitted by the 1993 Amendment.
With regard to potentially sick industrial companies the SICA has provisions for identifying impending sickness as of 50% or more of the net worth. If the accumulated losses of an industrial company in any financial year have resulted in erosion of 50% or more of its net worth during the immediately preceding 4 years (5 years reduced to 4 years by the 1993 Amendment), it is considered as potentially sick and in such cases the company shall within a period of 60 days from the date of finalization of the duly audited accounts of the company for the relevant financial year report to this effect to the Board and held a general meeting of the shareholders of the company for bringing the fact to their notice.
Industrial Sickness – Nature
The policy of over-regulation of the entire industrial sector, coupled with restrictions on closing a financially sick unit or reducing staff strength, led to a growing menace of industrial sickness, that is, the phenomenon of industry and business units running into a persistent loss and erosion of net worth.
Instances also came to light where the entrepreneurs deliberately made a unit financially sick by exploiting it for personal gain. Over years, the growing menace of industrial sickness not only assumed a cancerous form but also endangered the financial institutions, which had extended loans to them.
The phenomenon of industrial sickness has been fed by both fraudulent approach by the owners and the faulty policies pursued by the authorities. The government has been guilty of over-regulating the industrial units to an extent that left little scope for a reasonable return on investment by fair means.
At the same time, the government policies also provided an ample scope and temptation for frauds and mismanagement. Frequently, the permitted sales price was insufficient to cover the cost of inputs. The authorities also failed to formulate and implement a labour and wage policy in conformity with the needs of growing industrialization of the economy.
Normally, when a business unit turns financially sick, avenues should be explored for restructuring and reviving it. In the process, it may even be given a fresh injection of capital. In case this remedy is not expected to work, it should be allowed to close down. In India, however, the policy of the Government has been to keep these units alive through financial support from itself and from the financial institutions with the objective of protecting the jobs of the employees.
Industrial Sickness – Stages of Sickness in an Industrial Unit: Normal Unit, Tending towards Sickness, Incipient Sickness, Sickness and Chronic Sickness
Bidani and Mitra have identified four stages of sickness before a normal unit fails and finally closes down (see Table 3.6):
Stages of Sickness:
A healthy unit is one where all the systems and sub-systems, and all the functional areas like finance, production, marketing and personnel, are performing efficiently. That is, when a unit is earning sufficient profit, when its current ratio is more than one, when its tangible net worth is positive, and when its debt-equity ratio is reasonable, it may be termed as healthy.
Further, a healthy unit must also be capable of withstanding the ever-changing external environment, as the antibodies in a healthy human being fight the viral or bacterial infections.
Tending towards Sickness:
When certain aberrations start taking place in any of the functional areas of a unit, due to some internal problems or external (environmental) constraints, it may be said to be tending towards sickness. The indicators at this stage may be decline in the profit last year as compared to the previous year and the estimated losses in the current year.
At this stage, both the banker and the borrower would do well to carefully diagnose and analyze the various causes of the initial ailments and take the necessary preventive measures so that the unit may be saved from deteriorating further and falling sick.
If the initial aberrations are not arrested in time, the position may deteriorate and the actual sickness may set in.
This stage may be termed as the incipient sickness stage of the unit, which may be determined by the following factors:
i. The unit had incurred a cash loss during the last year and was expected to incur a cash loss even in the current year,
ii. Though the current ratio of the unit was more than one at the end of its last financial year, it was expected to deteriorate to less than one during the current financial year,
iii. The tangible net worth (TNW) of the unit was expected to contract during the current financial year.
iv. The debt-equity ratio of the unit was expected to deteriorate during the current financial year.
The bank officers may be able to detect the incipient sickness in a unit in time through an effective system of supervision and follow-up of the advances. After having done so, they should promptly review the overall position of the unit, identify the area of deficiency, and initiate the necessary corrective steps, in full cooperation with the entrepreneurs, with a view to preventing the unit from falling sick.
If the necessary corrective measures are not taken promptly at the incipient stage or are inadequate, the causal factors may continue to adversely affect the functional areas, gradually worsening the overall position of the unit, which may ultimately fall sick.
At this stage, the bank officers are expected to urgently undertake the detailed viability study of the sick unit. If the unit is considered viable, they should promptly formulate and implement a comprehensive rehabilitation programme with the close cooperation of the entrepreneurs, with a view to nursing the unit back to health. Timely action is of essence in such matters because delay may turn even a viable unit into a terminally sick unit. If the unit is, however, found to be non-viable for rehabilitation by the bank, the advance should be called up without delay so as to contain the losses of the bank and the borrowers.
Death or Closure of the Units:
When the company or unit continues to accumulate cash losses for a period of several years in the past, its manufacturing processes have stopped, and it has no access to finances, its revival is just not possible. This is the final stage of closure or death of a unit.
Industrial Sickness – Signals of Industrial Sickness
The sign of sickness may be discernable at quite an early stage. This warning sign is termed as “Signal”. In fact, the timely identification of various signals makes the detection of sickness easier. Therefore, the various signals as listed below need to be identified and monitored at an early stage.
The important signals of sickness are:
1. Decline in capacity utilisation
2. Irregularity in maintaining bank account
3. Non-submission of the data to bank financial institutions
4. Inventories in excessive quantities
5. Frequent break down in plant/equipments
6. Decline in technical deficiency
7. Decline in the quality of the products/services
8. Shortage of liquid funds for short-term financial obligations
9. Default in the payment of statutory dues
10. Frequent turnover of personnel in the industries.
The persistence of many signals for a long period of time is termed as symptoms of sickness, the various symptoms ultimately reflect on the plant performance (capacity utilization, financial capital ratio, share market value practices in the diverse areas of finance, production, marketing and labour relation in the industry).
Some of the important symptoms are:
1. Deteriorating financial ratio
2. Delay in the audit of annual account
3. Persisting shortage of cash flow
4. Continuous tumble in the price of the shares
5. Delay in the payment of statutory dues
6. Widespread use of creative accounting
7. Frequent request for loans
8. Morale degration of the employees
9. Desperation amongst the top and middle managerial level.
However, the financial ratios, in each case cannot be considered as true symptoms of industrial sickness.
It is over to two main factors:
1. The sickness prone unit – To present a better and sound image, one must do lot of window dressing.
2. Financial data – It may be available after a gap of one year.
However, an early identification of symptoms makes the task of detecting easier and fast.
Industrial Sickness – Causes of Sickness in Units: Problems in Production, Lack of Orders, Lack of Raw Materials, Cash Crunch, Increased Cost of Raw Material and a Few Others
There are many glitches that can lead to sickness among industrial units.
Some of the common causes leading to failing health of small units are discussed as follows:
1. Problems in Production:
Problems in production may arise due to:
i. Machine breakdowns, poor maintenance
ii. Poor quality of raw materials
iii. Poor labour productivity
iv. Power shortage
v. Lack of production, planning, and control
vi. Delayed supplies from sub-contractors
vii. Poor industrial relations.
2. Lack of Orders:
A unit may suffer as it does not get enough orders to match its anticipated or targeted production targets.
The lack of orders could be due to any of the following reasons:
iii. Low quality technical incompetence
iv. Irregular deliveries
v. Poor marketing efforts
3. Lack of Raw Materials:
Diminished or poor supply of raw materials could be due to:
i. National or regional shortage
ii. High cost
iii. Overdue payments to suppliers
iv. Poor quality
v. Uncertain suppliers
vi. Lack of planning.
4. Cash Crunch:
This arises due to any of the following:
i. Deliberate diversion of funds
ii. Well-intentioned but unwise diversion (e.g., unplanned diversification)
iii. Poor collections
iv. Unplanned payments to creditors
v. High inventory
vi. Unproductive and flamboyant expenditure
5. Increased Cost of Raw Material:
This is a common cause that may lead to the sickness of a unit.
It could be due to:
i. Increased costs not covered in selling prices due to faulty costing
ii. Large orders booked at fixed prices in an inflationary market
iii. High material wastage
iv. High inventory costs.
6. Increased Overhead Costs:
Increased overhead costs may arise due to:
i. Inefficient production
ii. Un utilized capacity
iii. Heavy borrowings, high interest charges
iv. Increased administration or selling costs
v. Unplanned capital expenditure
vi. New product development or diversification.
Industrial Sickness – Criteria to Identify Sickness/Incipient Sickness
In order to measure sickness, information on, whether the unit has outstanding source(s) of the loan (institutional/non-institutional), whether there was delay in institutional loan for more than 12 months and whether there was erosion in the extent of 50 per cent of the net worth during the previous accounting year, was collected in the Census.
On the basis of this information, the definition given by the Kohli Committee measure sickness. In other to measure incipient sickness, the continuous decline in three consecutive years was identified as a suitable indicator, and so information given was continuous decline in gross output compared to the previous two financial data collected.
Thus, the following criteria was adapted to identify sick/ incipient sick census:
(i) Continuous decline in gross output compared to the previous two financial years.
(ii) Delay in repayment of institutional loan, for more than 12 months, and
(iii) Erosion in the net worth to the extent of 50 per cent of the net worth during the accounting year.
Sickness/incipient being a leading question, the enumerators were asked from the entrepreneurs of the units satisfying at least one of the above criteria, and has not been running satisfactorily.
Industrial Sickness – Magnitude of Industrial Sickness in India
In the process of economical and industrial development a certain level of sickness is bound to exist as inefficient units are bound to be displaced from industrial scene by more efficient units.
Table 8.3 present the global phenomena of industrial sickness:
Table 8.4 depicts data on the number of total SSI vis-a-vis number of sick small scale industries during 1977-91 in India. A close look at this table clearly reveals that the growth of sick SSI unit far exceeds the growth of SSI units indicated by the ratio of sick units to total units. It can also be noticed that incidence of sickness in SSI units assumed alarming proportion during the eighties to quote the ratio of sick units to total units trailed at 1:20 to 1:5 by 1988.
The cause of very high incidence during the eighties is inter alia due to government liberalisation policy during sixth and seventh five year plans. During these periods there was a flood of SSI units competing with each other and resulting in more sick units. Due to heavy competition today the ratio of sick to total units stands at 1:10. The incidence of sickness has advanced to an extreme form making the majority of units non-viable.
At the end of 1991, out of 2.21 x 105 sick units 2.03 x 105 units (91.66%) were considered as nonviable. They have a credit of Rs.1997.13 crores i.e., 71.53% of total outstanding credit to all sick units. Thus, almost 9 out of 10 small units were found to be non-viable. These units cannot be cured, they are as good as dead units.
State-wise distribution of small units vis-a-vis sick SSI units is shown in table 8.5. This table reveals four distinctly different points.
Table 8.6 clearly reveals that no. of sick small units follow the following trends:
Eastern (44.7%), Northern (21.2%), Southern (17.6%) and Western Region (16.4%). However, in terms of outstanding book credit it follows- Western (31.3%), Southern (23.2%), Northern (24.1%) and Eastern zones (22.4%). Most of the sick units are iron and steel (41%) and others (22%) (Electricals, Chemicals, Textiles etc.)
Industrial Sickness – Reasons and their Consequences of Sickness
It cannot be attributed to a single factor alone. In fact, it is cumulative effect of many factors inter-related/independent of each other.
The main reasons for the sickness can be categoried as:
1. External or Exogenous causes
2. Internal or Endogenous causes
1. Exogenous Causes:
There may be several exogenous factors causing a unit sick. It may vary from time to time for industry to industry and/or even one time to other or the same industry.
The important external reasons may be:
(i) Shortage of financial resources
(ii) Labour unrest/strike
(iii) Lack of demands of the product
(iv) Change in industrial policy
(v) Poor inventory maintenance
(vi) Untimely supply of/purchase of raw materials
(vii) Natural calamities like food, earthquake, drought etc.
(viii) Recessionary trends hovering the industry.
All the above factors can be broadly classified as:
(i) Governmental policy
(ii) Natural calamities
(iii) Environmental conditions
2. Endogenous Reasons:
These are mainly due to some internal deficiencies in several functional areas, viz. personnel, production, marketing, management and/or finance.
Majority of the projects (54%) are found to be sick due to internal reasons like poor management, labour problems, operative problems, poor implementation and /or lack of sufficient working capital.
This type of sickness may occur at every stage as:
It happens during planning and construction stage. The unit may be located at an uneconomical location, adopted an inefficient method of production and/or planned to produce an obsolete item.
Unit might have committed some mistakes during recruitment, training of the workers, unestimation of various inputs (fund, labour, power, water etc.). It cannot be corrected easily at late hours.
It may arise even if the unit is in full swing. It may be due to demand of product which might have changed. New technologies might have taken place and/or new or more competitors have entered in the market.
Studies show that small scale units are mainly sick due to exogenous causes, whereas endogenous causes play important role in making large units sick.
Small units are so small that they cannot withstand fluctuation in the market, frequent change in government policy and/or market policies. They work with very small margin of profit and as such even small error may make them sick. Due to this, small units are highly prone to sickness.
The main consequences of enterprises sickness are:
1. Emergence of industrial unrest
2. Wastage of resources
3. Loss of tax payers revenues
4. Financial loss to banks/financial institutions
5. Loss of employment opportunities
6. Adverse effect on prospective entrepreneurs
7. Hardship to the public
8. Market fluctuation.
In a nutshell, whatever may be the reasons of sickness, the consequences are always same viz. loss of employment/production, economy hardship, chronic unemployment and shortage of goods. Thus, “industrial sickness is a blot on the country’s economy”.
Industrial Sickness – Consequences of Industrial Sickness: Huge Financial Loss, Rise of Industrial Unrest, Adverse Effect, Loss of Revenue to the Government and a Few Others
The main consequences of industrial sickness have led towards wastage of scarce capital assets, increase in unemployment, locking up of economy’s financial resources and loss of production.
Let us discuss the various consequences of industrial sickness in detail:
The banks and financial institutions provide substantial funds to start an industry. But due to industrial sickness huge funds has been locked up which has impinged on the future lending capacity of the banks and the financial institutions.
The recovery of the overdue takes an unduly long period of time and in many cases only a small portion of the overdue amount is finally recovered. Thus it bears an adverse effect on the financial health of the banks and institution.
The shutdown of a sick unit results into unemployment and leads towards industrial unrest. Whenever a worker is removed or retrenched from his job the trade union starts opposing the management’s decision and resort to strikes. Such type of disturbances threaten the peace and spoil the industrial environment. This results into set back of industrial production.
Due to industrial sickness, the share prices of the units goes down which in turn adversely affects the stock market of the country. Thus industrial sickness creates a psychological disinterest for investment among the prospective investors, leading towards non- conduciveness in the industrial development of the economy.
A substantial portion of the revenue is raised by the Government from the industrial units through various ways like taxes and duties. But this possibility of raising substantial revenues from the industries is reduced due to industrial sickness, thus industrial sickness results into loss of revenue to the Government. This shortage of revenue automatically effects the/ functioning of the economy as a whole.
Industrial sickness has resulted into a serious consequence of loss of employment resulting into socio economic problem. According to an estimation made, nearly 30 lakh workers are affected due to closure of sick and weak units.
In an under developed, country like India, there is a lot of scarcity of resources and if these resources are locked up in sick units, it becomes a wastage of scarce resource which if in case invested at a right unit would have yielded substantial returns to the economy.
Industrial Sickness – Prevention of Sickness: Term Lending Institutions, Commercial Banks, Entrepreneurship and the Government
Units falling sick have been studied extensively. Some units are born sick, some units are made sick, and in case of some units, sickness is thrust up on them. Four groups can play a dominant role in preventing units from falling sick.
1. Term lending institutions,
2. Commercial banks,
3. Entrepreneurs, and
4. The government.
If the term lending institutions take the following steps, sickness can be prevented:
i. Proper appraisal of management of the project
ii. Ascertaining the marketability of the end products of the unit before lending
iii. Extra care in assessing the suitability, technical feasibility of plant and machinery if it is second-hand one
iv. Ensuring the timely implementation of the project.
2. Commercial Banks:
Since the commercial banks are the ones providing resources for serving successfully, they have to take the following steps to prevent sickness:
i. Noticing that the withdrawals in the account do not exceed the permissible drawing power continuously over a period of time
ii. Frequent scrutiny of the ledger account with the master intelligences
iii. Frequent interaction with the entrepreneur
3. The Entrepreneur:
The successful running of the unit surely depends on the ability and sustainable effort of the entrepreneur. It is the entrepreneur who conceives, implements, and manages the project to avert sickness in the unit.
They can prevent sickness by:
i. Selecting the supplier of the machinery with care
ii. Doing the homework properly
iii. Paying adequate attention to the deficiencies in the unit
iv. Careful selection of the partners.
4. The Government:
The Government too can help in controlling sickness by not making sudden changes in the industrial policy such as – the following, which may destabilize the small units:
i. Several changes related to existing units
ii. Policy to discourage new investment
iii. Withdrawal of subsidies
iv. Opening up of reserved items for big industries.