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A study of the causes leading to the liquidation of agricultural enterprises

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Abstract

The viability of agricultural enterprises is of paramount importance. Their liquidation has harmful effects on broad strata of society. The aim of my research is therefore to analyze the leading causes of liquidation of agricultural enterprises. The research was led on 17 agricultural enterprises. This may help in the prevention and treatment of their insolvency. The research results show that a long-term agricultural production is not sustainable with a low equity capital. For the long-term maintenance it is necessary that the investors establish the enterprise with a capital according to the type of the production. The loan can not replace the entrepreneurs own resources, it is only complementary to it. The owners of agricultural businesses should strive to ensure that the paid-up share capital is kept in the firm, because in case of payment difficulties, this can be an adequate financial provision. Companies with financial problems can avoid liquidation if the crisis is detected in time by the leaders. However, the owners must organize the management of the enterprise so that it should have the necessary technical and economic knowledge. With an appropriate management, and use of means of crisis management, the liquidation of the enterprise can be prevented.
Applied Studies in Agribusiness and Commerce AP STR AC T
Agroinform Publishing House, Budapest SCIENTIFIC PAPERS
Introduction
In a market economy, legal regulation of winding up
poorly performing, unviable companies is indispensable. The
details of that regulation may vary from one country to
another, but its aims are universal, namely to turn around
companies that can continue in the long run despite
temporary insolvency on the one hand, and to wind up those
that are permanently insolvent on the other hand. Putting
unviable and insolvent companies into liquidation makes it
possible for other market players to use their assets more
effectively and more profitably.
When Hungarian lawmakers passed the Bankruptcy Law
(BL) in 1992, their primary aim was to put a quick end to the
following problems that were starting to appear in the
Hungarian economy and getting graver and graver in the early
1990s: chain debts among companies, liquidity problems
increasing in severity and frequency, and permanent insolvency
of companies (Erdôs, 2007). Bankruptcy proceedings often
failed to lead to agreement or to expedient reorganization and
tended to result in liquidation (Ers, 2005).
The 1993 amendment to the BL made it impossible for
bankrupt companies to file for bankruptcy and changed the
deadlines of the bankruptcy procedure in such a way that
they became impossible to keep, consequently the
proceedings could not be instituted. At the same time, the
number of new bankruptcy proceedings initiated per year has
been steadily growing. According to the surveys conducted
by Creditreform Magyarország between 1996 and 2008,
more than 1,000 new bankruptcy procedures were initiated in
2008, which is over 250% of the 1996 numbers.
Widespread insolvency among companies is harmful for
several reasons. The employees of companies that are wound up
tend to become unemployed, which on the one hand increases
state expenditure in the form of unemployment and social
benefits, while the diminished incomes of unemployed people
may lower demand, which in turn affects the earnings of other
market players adversely, on the other hand. The wage subsidy
that companies facing bankruptcy may be awarded by the
Labour Market Fund is another state expenditure with a low rate
of return. Of the 5.6 billion Forints paid out in 2006 for example,
only 1.1 billion Forints were paid back. Companies going out of
business further diminish the states income from taxes.
Owing to the special position of agriculture in the
Hungarian economy, companies liquidated in that sector
impact the economy and society negatively in a number of
other ways as well:
Agriculture plays a prominent role in meeting
consumers’ food requirements.
It is essential that agriculture should exploit
Hungary’s natural resources.
About 400,000 people are employed in agriculture
and food processing.
By providing livelihood for rural communities,
agriculture plays an important role in slowing the
stream of rural population moving to cities.
Based on the above, the fundamental aim of this study has
been to analyze the causes leading to the liquidation of
A study of the causes leading to the liquidation
of agricultural enterprises
Annamária Kotormán
University of Debrecen Faculty of Applied Economics and Rural Development
H-4032 Debrecen, Böszörményi út 138. Hungary
Summary: The viability of agricultural enterprises is of paramount importance. Their liquidation has harmful effects on broad strata of
society. The aim of my research is therefore to analyze the leading causes of liquidation of agricultural enterprises. The research was led on
17 agricultural enterprises. This may help in the prevention and treatment of their insolvency.
The research results show that a long-term agricultural production is not sustainable with a low equity capital. For the long-term
maintenance it is necessary that the investors establish the enterprise with a capital according to the type of the production. The loan can not
replace the entrepreneurs own resources, it is only complementary to it. The owners of agricultural businesses should strive to ensure that the
paid-up share capital is kept in the firm, because in case of payment difficulties, this can be an adequate financial provision.
Companies with financial problems can avoid liquidation if the crisis is detected in time by the leaders. However, the owners must
organize the management of the enterprise so that it should have the necessary technical and economic knowledge.
With an appropriate management, and use of means of crisis management, the liquidation of the enterprise can be prevented.
Key words: agricultural enterprises, liquidation, capital lost, risk, crisis management
124
agricultural enterprises in order to help them avoid and manage
b
ankruptcy. Of the 17 agricultural enterprises that were chosen
for analysis, 13 were located in Haj-Bihar County, and 4 in
Heves County; 15 of the 17 were cooperatives. The reason why
c
ooperatives are over-represented in the present non-
representative sample is that bankruptcy procedure often cannot
be instituted in limited-liability or limited partnership companies
(the two types most frequently affected by the BL) for lack of the
necessary documentation and information. Of the 17 companies
studied, one filed for bankruptcy in the first five-year period
following the introduction of the BL in 1992. In 10 companies,
bankruptcy proceedings were initiated between 1997 and 2001,
in a further five between 2002 and 2006, and in one in 2007.
Materials and methods
Following the literature on bankruptcy forecasting, the
study analyzed the following features of the 17 enterprises on
the basis of their final accounts and their annual reports of the
years preceding bankruptcy: liquidity quick rate, the current
assets/ total assets ratio, the proceed/after-tax profit ratio, and
the customer/supplier ratio.
In addition, the following data of the enterprises were
also examined: the make-up of the liabilities reported in the
final account, the degree of indebtedness, the ratio between
equity capital and liabilities total and the make-up of
accounts payable (the rate of long-term versus short-term
liabilities within liabilities total).
Further analyses were made of the net earnings by sales,
the profit and loss figures of operating/ business activity, the
profits on financial transactions and, finally, changes of the
balance sheet profit and loss figures over time, which can
throw light on the causes leading to permanent insolvency.
Claims made by creditors in the bankruptcy procedure may
differ from the value of accounts payable reported in the final
accounts, because it is only claims that have been made in the
period between the start of the bankruptcy procedure and the
deadline set by the BL (either 40 days or a year from the start of
the procedure) that are satisfied, provided the creditor has paid
the registration fee, which amounts to 1% of the value of his
claim. The study examines the make-up of the claims registered
by creditors and listed in the asset division proposal submitted by
the liquidator. The asset division proposal sets creditors’ claims
registered during liquidation against the assets that are available
for the company in liquidation for satisfying those claims.
Causes leading to the liquidation
of the studied enterprises
Based on the results of the analyses, it can be concluded
that the liquidation of the studied agricultural enterprises
were brought about by the following problems of Hungarian
agriculture after the transition in 1989:
1. Agricultural cooperatives were converted without
premeditation.
2. Agricultural cooperatives lost capital following
e
conomic conversion.
3. Their domestic and foreign markets narrowed.
4. The gap between the prices of agricultural and
i
ndustrial products increased.
5. Lending rates increased and subsidies decreased.
6. Losses made agricultural enterprises less adaptable to
economic change.
7. Following Hungary’s accession to the EU, and as a
result of increasing agricultural import, a number of
market players e.g. dairy farmers or fruit and
vegetable growers faced losses due to poor market
organization.
Of the 17 agricultural enterprises in this study, 13 were
successors of converted agricultural producers’ cooperatives.
Following conversion, 12 of them continued operating as
cooperatives, and one was converted into a joint stock
company. One of the enterprises that was set up as a
cooperative was not the successor of one, but it had taken
over an agricultural producers’ cooperative with huge debts.
Prior to conversion, two of the studied enterprises had
been stripped of assets to such a degree that their lack of farm
equipment doomed them to failure from the outset. The
management of one of the two cooperatives that were short
of capital when they were set up opted for voluntary winding
up, but had to face a compulsory winding-up order in the end.
Another agricultural enterprise used to get the bulk of its
income from sales of wine products on the Soviet market prior
to the transition of 1989. The loss of that market, however, made
the company unviable and insolvent. It was characteristic of all
the enterprises in this study that they did not have any income
from exports in the years before their liquidation. That was a
problem, because the higher prices achievable by exporting
could have offset the increasing costs of imported raw materials.
The studied enterprises were force to cut costs by not
investing into development or the safety of production, which
(combined with extreme weather conditions) led to
significant yield losses in crop production between 1997 and
2000. In 1997, producers in Hajdu-Bihar county were struck
by drought, whereas in the years 1998 and 2000 farmers in
Hajdu-Bihar and Heves counties suffered water damage (due
to too much precipitation) amounting to scores of billion
Forints, which made it impossible to work the land or to
harvest crops. The majority of the enterprises had financial
difficulties due to the losses suffered earlier and had, by the
time liquidation started, accumulated significant debts which
were partly bank loans, partly tax arrears. In several
agricultural enterprises bankruptcy was brought about by the
drop in earnings caused by decreased yields. Of the 17
agricultural enterprises that went bankrupt, liquidation was
initiated in 9 following drought and water damage. In order
to finance production, all 9 enterprises were forced to take
out loans secured by mortgage that could only be repaid by
selling equipment or livestock, which further weakened their
respective positions. At the end of that vicious circle or rather
spiral, the enterprises lost their creditworthiness and became
insolvent; liquidation could no longer be avoided.
Annamária Kotormán
125
Of the 17 liquidated enterprises in this study, one operated
a
s a production and marketing cooperative, buying and selling
vegetables. As a result of the unfavourable market situation of
2004, however, the cooperative made serious losses and, since
i
t did not have enough capital, insolvency was unavoidable.
An analysis of the reports of the studied enterprises
showed that the liquidity quick rate, the proceeds/after tax
profit ratio, the equity capital/ total liabilities ratio and,
finally, the rate of indebtedness had clearly indicated
financial failure prior to and at the beginning of liquidation.
In the years preceding liquidation, the average liquidity
quick rate of the enterprises in this study was significantly
lower than the expected value of 1.00, what is more, it went
on decreasing until the start of liquidation. (Figure 1)
The average proceeds/profit ratio of the 17 enterprises was
negative in the period immediately preceding liquidation,
which means that the considerable losses suffered earlier
played a decisive role in their insolvency. (Figure 2)
The enterprises had low levels of equity capital and a high
degree of indebtedness due to the following two causes
(Figures 3 and 4):
1. The majority of the enterprises had been making
losses for years before liquidation, consequently their
equity capital kept decreasing.
2. As most of the enterprises lacked the necessary
income to cover operation costs, they had to take out
loans which, however, did not cover tax liabilities.
In the enterprises in this study, accounts payable were
mainly short-term debts, overwhelmingly tax arrears
accumulated over the years.
An analysis of the indices has shown that the deterioration of
the liquidity rate, the decrease of the equity capital, accompanied
by the increase of the degree of indebtedness are warning signs of
impending insolvency. The afore-mentioned indicators should be
continuously monitored if bankruptcy is to be avoided.
Conclusion
Under Hungarian laws the minimum capital requirement
to start a company is low, consequently a great many
companies have been formed since the transition of 1989.
The two most common types are limited partnerships
where there is no legal requirement of a minimum of issued
capital and limited-liability companies which take no
more than 500,000 Fts to form since 2007, and where the
A study of the causes leading to the liquidation of agricultural enterprises
Figure 1. Changes of the liquidity quick rate prior to liquidation
(Source: the author’s own calculations based on reports)
0
,05
0
,27
2,57
0,00
0,15
1,42
0,00
0
,50
1,00
1,50
2
,00
2,50
3
,00
Minimum Average Maximum Minimum Average Maximum
I
n the Year before Liquidation At the Beginning of Liquidation
Figure 3. Changes of the rate of equity capital prior to liquidation
(Source: the author’s own calculations based on reports)
-112,72
12,92
73,62
-7 557,14
-6,80
59,57
-8 000,00
-7 000,00
-6 000,00
-5 000,00
-4 000,00
-
3 000,00
-2 000,00
-1 000,00
0,00
1 000,00
%
Minimum Average Maximum Minimum Average Maximum
In the Year before Liquidation At the Beginning of Liquidation
Figure 4. Changes of the degree of indebtedness before liquidation
(Source: the author’s own calculations based on reports)
6,01
83,21
212,53
40,43
106,75
40,43
0,00
50,00
1
00,00
150,00
200,00
250,00
%
Minimum Average Maximum Minimum Average Maximum
In the Year before Liquidation At the Beginning of Liquidation
Figure 2. Changes of the proceeds/profit ratio before liquidation
(Source: the author’s own calculations based on reports)
-13,88
-35,81
62,00
-154,13
-51,66
-1,00
-200,00
-150,00
-100,00
-50,00
0,00
50,00
100,00
%
Minimum Average Maximum Minimum Average Maximum
In the Year before Liquidation At the Beginning of Liquidation
126
owner’s liability is limited. Those companies have often been
f
ormed out of necessity, in an attempt to escape
unemployment. They tend to have a single source of income,
with the loss of which the company becomes unviable. The
e
nterprise that specialized in game management is a case in
point. When the managing director fell ill, the business
collapsed and had to be liquidated because of unpaid debts.
According to expert opinion enterprises most often go
bankrupt over tax debts. This study has found that, in most of
the studied agricultural enterprises, the Tax and Financial
Audit Office was both the greatest creditor and the initiator
of the bankruptcy procedure. Because of the high risks of
agricultural production, suppliers sometimes secure their
claims with the right of option. In two enterprises in this
study that is what caused bankruptcy. The low earnings of the
enterprises failed to cover their liabilities and, as a result,
suppliers took possession of their implements of production.
Contrary to bankruptcy forecasting literature, which
claims that bankrupt companies have characteristically low
rates of current assets, this study has found that the opposite
is the case in failed agricultural enterprises. The enterprises
in the sample were characterized by a decrease in invested
assets. As the fixed asset requirement of agricultural
production is considerable, a steady decrease of those assets
gradually makes their operation impossible.
An analysis of the causes of bankruptcy in the
agricultural enterprises of this study has identified several
problems the solution of which is the responsibility of both
the state and the individual agricultural entrepreneur.
Producers to have safe market positions, they have to
produce large quantities of consistently high quality products
and that can only be done by forming big, capital intensive
companies. The state can facilitate the formation of capital
intensive agricultural enterprises with subsidies or tax
incentives given to companies with high issued capital.
Capital concentration could also be increased by setting a
minimum requirement of issued capital for forming
enterprises for certain business activities, the same way as
law requires adequate qualifications for doing certain jobs.
Agriculture has always been a high risk business due to
the special circumstances of agricultural production. A
survey of the perception of risk factors conducted by Székely
et al. in 2007 found that Hungarian farmers in a pilot study
rated on a scale of 1 to 7 the weather as the number 1 risk
factor, and that was followed by the fluctuation of prices in
the second place. In order to manage the more and more
frequent risk of extreme weather conditions, Parliament
passed a bill in 2008 on the national agricultural loss
reduction plan and on the contribution to loss reduction,
putting it into effect with Decree 32/2009 (III. 31) of the
Ministry of Agriculture and Water Management on the
procedure of agricultural loss reduction. The plan consists of
two parts: the contribution of individual framers on the one
hand, and a state subsidy of matching funds of no less than the
former amount. That “insurance plan” provides loss reduction
in cases of frost, drought or water damage for farmers who
have joined the plan. *** Participation in the loss reduction
plan is compulsory for agricultural companies and small and
m
edium businesses, but optional for primary producers.
Agricultural producers can get loss reduction only if the loss
is/ damages are reported within 10 days of occurrence to the
s
pecial administrative division of the competent Agricultural
Office, while loss reduction claims must be handed in to the
regional office of the special administrative division by
October 20th of the year under review.
In 2009 crop producing enterprises have been estimated
to suffer approximately 50% yield loss due to various
disasters. Water damage in the first couple of months of the
year, drought from March on and the situation has recently
been exacerbated by storm damages. The expected price
increase generated by demand exceeding supply can only
partly offset the above losses. The loss reduction plan may
serve as an interim solution. However, loss adjustment
payments may well be deferred into 2010 because the
payment schedule to be submitted by the Ministry of
Agriculture and Regional Development by December 10th at
the latest cannot be drawn up before the EU Committee has
given its approval in the notification procedure. Since claims
of yield losses will not be paid in 2009, the costs of
agricultural production in that year will have to be covered
by the producers. In that way, enterprises lacking the
necessary assets may go under despite the introduction of the
loss reduction plan.
In the author’s experience, managers of small businesses
especially find it difficult to interpret accounting data, and
they also tend to be poorly informed about tax rules. Without
that information, the annual business plan (if there is one)
will not be well-founded, and the enterprise may go bankrupt
even if its manager knows all the ins and outs of his special
field. This can only be avoided by making sure that the
managers of enterprises are well-versed in business
management as well as their special fields.
Should an enterprise get into a critical situation,
bankruptcy can still be avoided by employing the methods of
crisis management, provided the situation is recognized in
time. In that way the enterprise survives the crisis, creditors
get paid, and jobs are saved. Unfortunately, crisis
management is not widely used in Hungary partly due to the
attitude of the enterprises in financial difficulty and partly
due to the creditors’ lack of confidence in the method,
although the latter could play an important part in turning
around the ailing enterprise. As an incentive for using crisis
management methods, the state could subsidize companies
the same way that it subsidizes consultation.
The wave of liquidations that started in 2009 has also
been enhanced by the wide-spread practice of chain debts
which makes a growing number of companies face
bankruptcy. Claim management as well as customer rating is
becoming more and more important because they are
indispensable if marketing risks are to be lowered.
Crisis management and claim management, however,
require ample capital, which again underlines the fact that
enterprises that are short of capital are not viable in the long
run.
Annamária Kotormán
127
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A study of the causes leading to the liquidation of agricultural enterprises
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A hazai csôdjog átfogó reformjának kérdései Kockázatkezelés az európai mezôgazdasági vállalkozásokban
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