What is Financial Restructuring?

Financial restructuring is the reorganizing of a business' assets and liabilities. The process is often associated with corporate restructuring where an organization's overall structure and its processes are revamped. Although companies can restructure for any reason, in most cases it is done when there are serious problems with the business, and to avoid bankruptcy liquidation.

Every functioning company controls assets, or economic resources that can be owned and are otherwise considered valuable. Most businesses also hold liabilities, which are debts or other obligations that arise as a result of past transactions. These economic factors will often have the most significant impact on the success or failure of that business, so financial restructuring is likely to focus on effectively managing assets and reducing liabilities.

When a company is in crisis, it may try to renegotiate with its creditors to reduce or eliminate some of its debts. Faced with the possibility that the distressed company may default on a loan, creditors will often work to adjust the terms of repayment, including lowering interest rates and/or extending the repayment schedule. Debts may also be forgiven, in part, often in exchange for the creditor gaining some equity — part ownership — in the company.

Financial restructuring is not only a tool used by companies that are in financial trouble. Healthy companies may also choose to restructure their debt if it will provide a benefit. If interest rates fall, for example, a company may refinance its loans to take advantage of this drop.

Companies that have little debt in comparison to their equity — that is, they are are underleveraged or have a low debt-to-equity ratio — may use some of their equity to buy back stock. This returns more control to the company, which will have fewer stockholders to satisfy and pay dividends to. If the company has excess cash, it can use it to repurchase shares; alternatively, if it doesn't have extra cash available, it may sell off some assets that are not bringing in profits or borrow money for the buyback.

Financial restructuring can also involve writing down assets that are overvalued. This change in value appears on a company's income statement as an expense, which lowers the company's income and, therefore, the amount of tax it owes. Because this is a "paper loss" — the company isn't actually losing any money except on the income statement — this method of restructuring can help reduce how much money a company owes without it needing to spend cash on repurchases.

Most businesses go through a phase of financial restructuring at some point, though not necessarily to address shortfalls. In some cases, the process of restructuring takes place as a means of allocating resources for a new marketing campaign or the launch of a new product line. When this happens, the restructure is often viewed as a sign that the company is financially stable and has set goals for future growth and expansion.

A company may also need to restructure its finances if it merges with or acquires another company. When two firms merge, their debt and equity are also combined, and the resulting corporation may have a very different debt-to-equity ratio than either of the original companies. An acquisition may even be used as a form of financial restructuring, as a company with a low debt-to-equity ratio may target a business with a high ratio as a means of better balancing its finances.

Along with financial restructuring, a company may need to restructure its operations to help eliminate waste. For example, two divisions or departments of a company may perform related functions and in some cases duplicate efforts. Rather than continue to use financial resources to fund the operation of both departments, their efforts are combined. This helps reduce costs without impairing the ability of the company to achieve the same ends in a timely manner. Operational restructuring, also known as corporate restructuring, may also involve downsizing, eliminating staff to reduce costs.

In some cases, restructuring must take place in order for the company to continue operations. This is especially true when sales decline and the corporation no longer generates a consistent net profit. The operational restructuring process may include a review of the costs associated with each sector of the business and an analysis of ways to cut costs and increase the net profit. The process may also call for the reduction or suspension of obsolete facilities that produce goods that are not selling well and are scheduled to be phased out.