Fastest Growing Economy of the World suffering from huge Stressed Assets and NPAs. Why?

The Fastest Growing Economy of the World is suffering from huge stressed assets & NPAs. Why?

Reasons: 
Poor Risk Assessment & 
Failure of Corporate Governance

By

Vijay Sardana

Today big names in infrastructure, real estate, capital goods, pharma companies, rice, edible oil, many food companies are Non-performing Assets (NPAs) in a fastest growing economy of the world. In the same regulatory regime some are doing very well, and others are becoming NPAs. 

Is this the fault of policy makers or the fault of business managers and Board of Directors? 

What do you think?

What is Business Risk?

Business risk is the possibility a company will have lower than anticipated profits or experience a loss rather than taking a profit.

Business risk is influenced by numerous factors, including sales volume, per-unit price, input costs, competition, the overall economic climate and government regulations.

A company with a higher business risk should choose a capital structure that has a lower debt ratio to ensure it can always meet its financial obligations.

These fundamentals were ignored at all levels either due to ignorance or lack of prudent systems in place. Classic case of failure of Corporate governance and their own overconfidence that nothing will go wrong this mindset never allowed them to develop good risk assessment system and all information was manipulated to suit the bankers and promoters wish list.

Financial Business Risks were never evaluated properly

Business risk impairs a company's ability to provide its investors and stakeholders with adequate returns. The company is also exposed to financial risk, liquidity risk, systematic risk, exchange-rate risk and country-specific risk. This makes it increasingly important to minimize business risk.

To calculate the risk, analysts use four simple ratios:

1.     Contribution margin,

2.     Operation leverage effect,

3.     Financial leverage effect, and

4.     Total leverage effect.

For more complex calculations, managers can incorporate statistical methods.

Most of the feasibility reports submitted to the banks were having manipulated data and Directors of the board never question these numbers either due to ignorance or due to lack of will to examine the facts.

Specific Types of Business Risk:

Business risk usually occurs in one of four ways:

·       Strategic risk,

·       Compliance risk,

·       Operational risk and

·       Reputational risk.

Strategic Risk:

Strategic risk arises when the implementation of a business does not go according to the business model or plan. A company's strategy becomes less effective over time, and it struggles to reach its defined goals. If, for example, any company strategically positions itself as a low-cost provider and competitors decide to undercut prices, this becomes a strategic risk.

Compliance Risk:

The second form of business risk is compliance risk. This type of risk arises in many industries and sectors highly regulated with laws.

The industries, for example, must adhere to various environmental protection and consumer protection compliance requirements and compliance risk arises when a brand fails to understand the individual requirements and becomes non-compliant with state-specific laws.

Operational Risk:

The third type of business risk is operational risk. This risk arises when the day-to-day operations of a company fail to perform.

For example, the company faced operational risk and a heavy fine when its internal systems failed to deliver quality services and in violation of the applicable laws and operations team was unable to adequately identify the Risk and Risk Management Committee of the Board also failed to evaluate the effectiveness of operational SOPs.

In today's, hyper-connected world via internet, any time a company's reputation is ruined, either by one of the previous business risks or by something else, it runs the risk of losing customers based on a lack of brand loyalty. On the other hand, the company faced a high risk of losing its reputation when the heavy fine is levied for poor practices.

What is the way forward?

Companies invested decades to build their reputation and lost the same with one incidence due to poor SOP or poor corporate governance.

When regulations and business environment is changing daily, the fundamental mistake companies do is by claiming there have adequate systems in place without even reviewing the same in the last few years and without training staff on the revised systems. This is nothing but ignorance and trying to hide ignorance. There is no fun in hiding ignorance because it can be fatal for all.

How to Prevent NPAs?

According to Jack Welch, Former Chairman & CEO of General Electric mentioned in his book "Winning",  It is the universal fact; very often In-house managers have tendency to please bosses and to provide rosy pictures to protect their jobs. This can be fatal because fault-lines are hidden under the cooked-up data.

Take professional help from professionals those who understand your business and products and have frank discussion because it is important to protect health of your company. There should be critical discussion on all business assumptions to avoid wrong assumptions and to have fair assessment.

If required, managers should be trained and there should be training programs for the Board of Directors to educate them about the business and emerging trends in business. This will help them to evaluate the business and guide the executive management properly.

You may read other relevant articles on the blog and send your queries or requirements to the author at: sardana.vijay@gmail.com

Let us discuss how to address the business risk in your organisations.