FI 6 Financially Troubled Entities

Question 1

What are symptoms of financial distress?

Answer 1

Lower profits or losses
Low or no cash balances
High short-term debt balances
May have negative operating cash flows

Question 2

What will ratios look like if company is in distress?

Answer 2

• current ratio very low, less than 1
• quick ratio very low
• high debt-to-equity and debt-to-asset ratios
• operating and profit margins will be low or negative

Question 3

Some costs of financial distress (non financial)

Answer 3

loss of reputation
loss of employees
underinvestment in capital assets or selling assets below market price
low employee morale
management operating in crisis mode
suppliers cutting product lines to company
inability to raise external funds
breach of covenants and their implications

Question 4

What two types of problems are there?

Answer 4

Operational and financial

Question 5

How is free cash flow determined?

Answer 5

Revenues less costs less income taxes less investments in capital assets and w.c.

Question 6

What three things deem a company to be insolvent and therefore protected from creditors under CCAA or BIA

Answer 6

• FMV of assets less than FMV of liabilities
• debtor unable to pay obligations as they are due
• debtor reasonably expected to run out of liquidity prior to restructuring

Question 7

Adv / Disadv of informal negotiations with creditors

Answer 7

+ flexbile and quick
+ creditors may agree to terms, reducing costly legal proceeding
+ inexpensive
+ negotiations are private
+ employees may stay if they see negotations
+ management and shareholders stay in control
- some credtors may not want to negotiate and hold out
- the more creditors involved, the more difficult it is
- creditors may not have all info needed and so not make a deal

Question 8

Two types of formal legal proceedings

Answer 8

CCAA - owe $5m+/ BIA - owe $5m-

Question 9

Ranking of creditors

Answer 9

Super-priority - employees owed inpiad wages, government owed remittances etc
Secured creditors - creditors whose debt is secured by company assets
Preferred creditors - trustees and lawyers for fees, landlords owed rent
Unsecured

Question 10

Liquidation value

Answer 10

Net proceeds received for sale of assets net of any direct and indirect disposal costs and net of any o/s liabilities