Financial restructuring is the process of reshuffling or reorganizing the financial structure, which primarily comprises of equity capital and debt capital. Financial restructuring can be done because of either compulsion or as part of the financial strategy of the company. This financial restructuring can be either from the assets side or the liabilities side of the balance sheet. If one is changed, accordingly the other will be adjusted.
The two components of financial restructuring are;
- Debt Restructuring
- Equity Restructuring
1. Debt Restructuring
Debt restructuring is the process of reorganizing the whole debt capital of the company. It involves reshuffling of the balance sheet items as it contains the debt obligations of the company. Debt restructuring is more commonly used as a financial tool than compared to equity restructuring. This is because a company’s financial manager needs to always look at the options to minimize the cost of capital and improving the efficiency of the company as a whole which will in turn call for the continuous review of the debt part and recycling it to maximize efficiency.
Debt restructuring can be done based on different circumstances of the companies. These can be broadly categorized in to 3 ways.
- A healthy company can go in for debt restructuring to change its debt part by making use of the market opportunities by substituting the current high cost debt with low cost borrowings.
- A company that is facing liquidity problems or low debt servicing capacity problems can go in for debt restructuring so as to reduce the cost of borrowing and to increase the working capital position.
- A company, which is not able to service the present financial obligations with the resources and assets available to it, can also go in for restructuring. In short, an insolvent company can go for restructuring in order to make it solvent and free it from the losses and make it viable in the future.
Components of debt restructuring
The components of debt restructuring are as follows
- Restructuring of secured long-term borrowings
- Restructuring of unsecured long-term borrowings
- Restructuring of secured working capital borrowings
- Restructuring of other term borrowings
Restructuring of secured long-term borrowings: Restructuring of secured long-term borrowings will be done for the following reasons such as reducing the cost of capital for healthy companies, for improving liquidity and increasing the cash flows for a sick company and also for enabling rehabilitation for that sick company.
Restructuring of unsecured long-term borrowings: Restructuring of the long-term unsecured borrowings will be done depending on the type of borrowing. These borrowings can be public deposits, private loans (unsecured) and privately placed, unsecured bonds or debentures. For public deposits, the terms of deposit can again be negotiated only if the scheme is approved by the right authority.
Restructuring of secured working capital borrowings: Credit limits from commercial banks, demand loans, overdraft facilities, bill discounting and commercial paper fall under the working capital borrowings. All these are secured by the charge on inventory and book debts and also on the charge on other assets. The restructuring of the secured working capital borrowings is almost all the same as in case of term loans.
Restructuring of other short term borrowings: The borrowings that are very short in nature are generally not restructured. These can indeed be renegotiated with new terms. These types of short-term borrowings include inter-corporate deposits, clean bills and clean over drafts.
2. Equity Restructuring
Equity restructuring is the process of reorganizing the equity capital. It includes reshuffling of the shareholders capital and the reserves that are appearing in the balance sheet. Restructuring of equity and preference capital becomes a complex process involving a process of law and is a highly regulated area. Equity restructuring mainly deals with the concept of capital reduction.
The following are the some of the various methods of equity restructuring.
- Repurchasing the shares from the shareholders for cash can do restructuring of share capital. This helps in reducing the liability of the company to its shareholders resulting in a capital reduction by returning the share capital. The other method that falls in the same category is to change the equity capital in to redeemable preference shares or loans.
- Restructuring of equity share capital can be done by writing down the share capital by certain appropriate accounting entries. This will help in reducing the amount owed by the company to its shareholders without actually returning equity capital in cash.
- Restructuring can also be done by reducing or waiving off the dues that the shareholders need to pay.
- Restructuring can also be done by consolidation of the share capital or by sub division of the shares.
Reasons behind equity restructuring
The following are the reasons for which equity restructuring is done:
- Correction of over capitalization
- Shoring up management stakes
- To provide respectable exit mechanism for shareholders in the time of depressed markets by providing them liquidity through buy back.
- Reorganizing the capital for achieving better efficiency
- To wipe out accumulated losses
- To write off unrecognized expenditure
- To maintain debt-equity ratio
- For revaluation of the assets
- For raising fresh finance