Debt restructuring is a method which enables a public or private organization or a state government facing financial distress and debt flow problems to restructure and settle its delinquent unsecured debts in order to improve or augment liquidity so that it is able to carry on its daily operations. It is also known as debt management or credit counseling. This method is used to restructure an enterprise’s debt in such a way that the interest rates are lowered and the outstanding debt is consolidated so as to allow for better payment of the principal. There are various ways of restructuring the debt of an organization and the interest rates and installment amounts are negotiated depending upon the financial situation of the enterprise and of the borrower. The debtors are normally given a grace period of three months after which the creditors will be ready to negotiate the terms of the debt restructuring with the debtor.
When an enterprise finds it facing financial distress, the first step towards debt restructuring occurs by looking at the current cash flow situation. To do this, one has to estimate how much additional cash would be made available if the existing debt restructuring was carried out. One can arrive at this calculation by estimating the annual revenues of the organization and the expenses required for operation. This calculation will give a rough idea of the net cash required for carrying on the day-to-day activities of the organization. This amount can be used as a baseline for estimating the effect of any proposed changes in the debt restructuring.
Another way of coming up with an accurate calculation of the necessary extra cash is to make use of the existing debt restructuring provisions embedded in the operating agreement. These provisions give the details of the amount of extra cash required from the creditors in case the debtor fails to meet the terms of the restructuring plan. This enables the creditor to calculate the financial damage caused to them if the debtor does not comply with the restructuring plan and thereby satisfies them about the need for providing assistance.
Creditors are willing to provide assistance to a debtor only if they are sure that their money will be repaid in the long run. This is why creditors are often prepared to restructure the debts of the business owners as and when necessary. They feel confident enough that there is a possibility that the business owner will repay the debts provided that he gets financial support from other sources. Hence, if a business owner is not able to meet the terms of the restructure plan, they may opt for bankruptcy instead of trying to recover the debts from him. The effect of this tactic on the reputation of the creditor is also negative, as the public will not want to deal with a creditor who is making unusual moves just to get out of paying debts.
In certain cases, creditors may be forced to resort to bankruptcy if their efforts to restructure the debt of the business owners are only going to lead to failure. If this happens, the effects of the decision to declare bankruptcy will have long term adverse effects on the public’s confidence in all kinds of debt restructuring practices. It will also reduce the government’s credibility. The public will lose faith in the ability of the government to solve such complex financial problems without causing long-lasting damage to the economy. This would affect the trust in other institutions including banks, which rely heavily on credit facilities.
A very effective method of debt restructuring for small businesses is debt mediation. Under this concept, the creditor agrees to accept a payment less than the full amount due to the debtor. The debtor then pays the remaining amount to the creditor over a period of time. Debt mediation helps resolve the problem of small businesses that have become unable to meet their payment deadlines due to economic hardships. In some cases, it even allows the business to resume operations if it has enough cash reserves.
The major advantage of debt restructuring for small businesses is the avoidance of bankruptcy. Small businesses have a better chance of recovering from bankruptcy if they can arrange a reasonable repayment plan with their creditors. This is why creditors are prepared to offer generous debt restructuring deals even if their own survival is at risk. They risk losing some, if not all, of the money they lent out to debtors who have opted for bankruptcy.
Borrowers will also be able to benefit from debt restructuring, even if they do not choose to file for bankruptcy. If the lender and the borrower reach a standstill agreement, the lender may be able to offer a reasonable repayment plan. The repayments will be lower than what the borrower would have paid if they had filed for bankruptcy. Such a plan will still allow the borrower to make payments according to a schedule agreed upon between both the lender and the borrower.