Sudhir Kumar Rakesh, IAS (Retd.)
Patna : Many Indian as well as International Companies are facing acute problems after the outbreak of Coronavirus Pandemic. Many of them are telling their respective governments that unless massive financial packages are made available immediately, these companies may not be able to survive. If they go down because of non-availability of survival / revival packages, it may result in loss of hundreds of thousands of jobs, apart from sinking of millions (even billions) of dollars worth of enterprise.
If start-ups or new businesses make such hue and cry, it may be understandable. But if the cacophonous noises start coming from large corporate houses, having varied product lines, then it is a matter of concern and needs to be analysed. If such large companies with decades of standing and history of creating wealth for themselves also join the bandwagon, it becomes difficult to absorb.
Did these companies make hay only while the sun shone? Did they not follow even the basic principles of carrying out large corporate businesses ? Did the tendency to show large profits even at the cost of fundamental principles of corporate governance (specially those related to creation of sinking funds, making provisions and creating healthy reserves in the balance sheet) become so overpowering that their boards looked the other way while the day to day management created a sure shot recipe for disaster?
One of the basic principles for any large corporate entity is the creation of Reserves. A reserve is generally defined as the portion of earnings, receipts or other surplus of an enterprise (whether capital or revenue) appropriated by the management for general or a specific purpose other than provision for depreciation or diminution in the value of assets or known liability.
Investopedia defines a reserve fund as a savings account or other highly liquid asset set aside by an individual or business to meet any future costs or financial obligations, especially those arising unexpectedly. For example a homeowners’ association often manages a reserve fund to help maintain the community and its amenities using the dues paid by home owners.
The Companies Act 2013 states that when security premium has to be recorded in the balance sheet, it is done in the Reserve & Surplus mentioned under the Equity & Liabilities of a company’s balance sheet. It is added only because the premium received by the company is an income for them.
A reserve fund sets aside money for covering scheduled, routine and unscheduled expenses that would otherwise be drawn from a general fund. Governments, financial institutions and private households many establish reserve funds. Although the fund size may vary, the typical goal is to deposit funds on a regular basis in an account that accrues interest, thereby increasing the fund’s value while not in use. Because expenses may arise unexpectedly, a reserve fund is typically kept in highly liquid account, such as a savings account.
In the business world, future losses are inevitable, whether it be for the falling resale value of an asset, malfunctioning products, lawsuits or a customer that can no longer pay what it owes. To account for these risks, companies must ensure they have enough money set aside.
In the context of the present CORONA Crisis, we may find which companies have followed basic principles of corporate governance by looking at the size of their reserve funds. These large companies operate themselves on the basis of shareholders’ money, public borrowings and investment by certain categories of people/institutions.
Corporates create wealth and surpluses for themselves at the cost of Public Borrowing and Financial Institutions. They need to be transparent and use such accumulated Reserve Surplus in order to help themselves, the stakeholders as well as the society at large in times of such crises. They cannot be allowed to mismanage huge amount of a nation’s financial resources. In other words, they have to be accountable. It is to be found out whether they are utilising these surpluses for alleviating the current critical situation or only raising hue & cry to divert attention from their Surplus & Reserves earned from the society at large by way of business profits.
In the case of India, we shall do well to legally and socially audit those companies which are crying themselves hoarse for governmental packages even before one month of Lockdown. Did these companies keep adequate reserve funds on their balance sheets? If not, what were their boards doing? What was their Director (Finance) doing? What were their other Directors (including Independent Directors) doing? Was the question of keeping adequate reserve funds on their balance sheets ever discussed in their board meetings? If not, why? If yes, what was the outcome?
The exercise should not be carried out in the nature of “fault finding”, rather it should be done in the spirit of “fact finding” and for bringing in more transparency. It may prepare us better for future. We may be able to plan better. Failing to plan is planning to fail!