Financial Restructuring: A Brief Guide

Roshni Khatri

14th Oct'22
Financial Restructuring: A Brief Guide | OpenGrowth

Financial restructuring is the most effective process for your business. We are all aware that finance plays a vital role in entrepreneurial journeys and is the most prominent aspect of any business activity. 

 

Many elements must coexist and be constant for an organization to expand. There could be a change at any time that impacts your original business plan's profitability. These ebbs and flows can provide a dynamic combination, ranging from market volatility and technological disruptions to shifting client want. 

 

Even if your business initially prospers in these conditions, it will inevitably run into difficult situations, some of which may cause it to enter into a financial crisis. At this point, businesses begin to think about starting a financial reorganization procedure.

 

So here we will discuss financial restructuring and its role in enhancing the value of your business. Let’s Start!

 

Financial Restructuring

Financial restructuring involves substantially altering your company's operational and financial strategy to prevent it from experiencing a pattern of losses. It usually implies when your business is coping with some extreme monetary pressures like crushing debt or sky-high operating costs. And you are not in a state to continue with the same models as before.

 

Financial Restructuring

 

The restructuring process typically includes cost reduction or asset sales to manage cash flow and reduce debt. With this, you should also know about the basics of small business loan to provide better financial assistance to your venture.

 

Steps Involved in Financial Restructuring

Some prime steps involved in the financial restructuring process are described as under:

  • A thorough analysis of a company's short- and long-term financial needs to ensure that it will develop its core strengths.

  • To progress to the next stage of financial restructuring, all key stakeholders must be quickly identified and mapped into several categories. It will safeguard the value and reduce the possibility of the company going bankrupt.

  • To prepare for potential unforeseen circumstances, the company should create multiple plans. Laying the groundwork for the development of the financial restructuring should be the goal of the initial phase of analysis, assessment, and negotiation.

  • A proposal for financial restructuring should be made while considering effective processes, value preservation, and tax efficiency.

  • A new version of the plan may be required due to changes in the economic climate, recent events, and stakeholder requests. 

 

Types of Financial Restructuring

This financial reorganization can be done from the balance sheet's assets or liabilities. If one is altered, the other will follow suit and be modified. The prime modes of financial restructuring are described as under:

 

Debt Restructuring

The process of restructuring the company's debt is known as debt restructuring. Rearranging the balance sheet items is necessary because it lists the company's debt commitments. 

Debt restructuring is more frequently employed as a financial tool than equity restructuring. This is because a business's finance manager must always consider ways to reduce the cost of capital and increase overall company efficiency, which in turn necessitates a constant evaluation of the debt component and its recycling to achieve maximum efficiency.

However, debt restructuring can be done based on different circumstances. Still, these can be categorized in three ways:

  • A healthy business can choose to restructure its debt by replacing its present high-cost debt with lower-cost borrowings, taking advantage of market opportunities.

  • A corporation that is having issues with liquidity or limited debt servicing capacity may choose to restructure its debt to lower borrowing costs and improve its working capital situation.

  • A corporation that is having issues with liquidity or limited debt servicing capacity may choose to restructure its debt to lower borrowing costs and improve its working capital situation.

 

Components of Debts Restructuring

Following are some elements of debt restructuring:

  • Restructuring from secured long-term borrowings

  • Restructuring through long-term unsecured borrowings

  • Restructuring through secured working capital

  • Restructuring of other term borrowings

 

Conversion of Debt to equity

Swap, a sort of financial restructuring agreement between a firm and its lenders under which the debt components of the company are changed into the equity of the business, is another name for converting debt into equity. As stated, the debt servicers take ownership of the company.

 

A debt-equity swap typically occurs when a company is experiencing financial difficulty but the lenders opt to sustain it after evaluating the feasibility of the business model and the promoters' commitment.

 

Financial Restructuring

 

Companies must obtain approval from the National Company Law Tribunal (NCLT). Based on several factors, including the submitted value analysis, NCLT may approve an order to confirm a share swap. 

High leverage or uncontrollable occurrences frequently impact business, resulting in the enterprise's sustainability. 

 

In these situations, lenders must choose whether selling the company's assets makes more sense or converting the loan into equity will benefit them more. Additionally, by taking on ownership of the company, the lender can benefit more from any favorable business developments as opposed to paying fixed interest on their debt as is customary.

 

It gives businesses the necessary money for survival, lowers the cost of interest, increases free cash flow to equity, and prevents the company from going into default.

 

However, the interest of current equity stakeholders is diluted due to the conversion of debt into equity. To reduce the risk, lenders typically demand significant discounts from the intrinsic value of a distressed company. 

 

Equity Restructuring

Reorganizing equity capital is the process of equity restructuring. It also involves moving the reserves shown on the balance sheet and the shareholders' capital. 

Equity and preference capital restructuring develops into a complicated legal process and is a highly regulated subject. Capital reduction is the primary concern of equity restructuring. 

 

When a corporation is overcapitalized, its earnings are insufficient to support a reasonable return on the number of securities it has issued. When it is undercapitalized, its capital is significantly less than its borrowed capital. 

 

When a firm's profits are much higher than those of other businesses or the value of its assets is far more than the capital raised, the company is said to be under-capitalized. Both undercapitalization and overcapitalization situations can be restructured, and appropriate solutions can be used.

 

Components of Equity Restructuring

Following are some prime components of equity restructuring, have a look:

  • Restructuring the share capital may be accomplished by purchasing shares directly from shareholders for cash. Returning the share capital aids in lowering the company's liability to its shareholders, resulting in a capital reduction.

  • The other technique in this category is converting equity capital into loans or redeemable preference shares.

  • Writing down the share capital using the proper accounting entries allows for restructuring equity share capital. As a result, the corporation will owe its shareholders less money without repaying equity capital in cash.

  • Restructuring can also be accomplished by lowering or eliminating the required shareholder dues. 

  • The share capital may be consolidated, or the shares may be subdivided as another kind of restructuring. 

Thus financial restructuring can be done by any particular mode at your convenience. When we talk about financial restructuring, we should know the facts of funding a business with self financing as it can be the most economical way to invest the funds. 

 

Conclusion

When the best course of action is decided upon, it should be implemented quickly and without incident to resolve the existing financial problems without interfering with the company's operation. 

 

Measuring success also requires defining realistic goals for a company's turnaround, allocating time to assess the results, and being open to innovative solutions. 

 

However, because financial restructuring is a dynamic process, any changes to internal or external factors, such as the economic environment, can significantly alter projections. 

 

We at OpenGrowth, are committed to keeping you updated with the best content on the latest trendy topics from any major field. Also, both your feedback and suggestions are valuable to us. So, do share them in the comment section below.

A keen observer, who loves to spend time with nature. A fun loving person, enjoys to explore the new aspects of life. Passionate about reading and learning new things. Roshni is dedicated towards her work and has worked in different professions.

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