New code of business crisis, an opportunity for SMEs

The new corporate crisis code

From August 2020, the new corporate crisis code will be fully operational. After more than seventy years, it has systematically reformed the bankruptcy law and introduced alert procedures. The latter are based on two pillars: the organizational obligations, according to which companies must equip themselves with "organizational structures suitable for the timely detection of the crisis", and the alert instruments, which must make crisis cases emerge early. The rules also provide for the establishment of the Ocri (crisis and insolvency settlement body), extra-judicial bodies set up in the chambers of commerce to collect reports and manage crisis situations.

The objective of the reform is to favor the reorganization of companies that are in a situation of temporary crisis and to make the exit from the market of companies that are instead in a situation for which the crisis is irreversible faster and less expensive. A monographic chapter of the Cerved Pmi Report, on which this article is based, is dedicated to the reform.

The regulations have entrusted the National Council of Chartered Accountants and Accounting Experts (Cndcec) – which has chosen Cerved as its scientific partner – to develop precise indexes that reasonably assume the state of crisis. The Board has proposed a sequential approach: in the case of negative shareholders' equity or under legal obligations, a state of crisis is presumed. If the heritage is positive, look at the DSRC (debt service coverage ratio), which is based on the relationship between liquidity generated by the company and financial obligations in the following 6/12 months: if the index is less than 1, the state of crisis is presumed, if it is greater than 1 there is no presumption of crisis. In cases where the index is not calculable or unreliable, five financial statement ratios are considered: if the company shows a situation of difficulty with respect to all the indices, a state of crisis is presumed.

The DSRC is therefore a crucial element for the early emergence of cases of crisis, but it requires treasury systems that today are not widespread in Italy, especially among small and medium enterprises.

Without investments by companies in treasury systems, it will be necessary to rely on the five financial ratios, which by their very nature "look to the past" (backward looking). Behind their choice and the related thresholds there is a trade off: with loose thresholds, a large number of alarm signals are generated, which also concern companies that are not in an actual crisis situation ("false positives"); with stringent thresholds, the number of signals is reduced and therefore the capacity to make a significant number of crisis cases emerge early.

Among the two alternatives, the Cndcec has paid great attention to the containment of false positives, adopting very stringent thresholds, above all to avoid clogging the Ocri in a running-in phase and to avoid the onset of a consistent flow of "unlikely to pay " (Utp) in the banks' balance sheets: according to our estimates, calibrating the indices to intercept half of the insolvencies "would cost" about 150 billion Utp per year of "false positives".

Figure 1

Conversely, simulations on historical data indicate that the five index system proposed by the Cndcec makes it possible to minimize false positives and the relative UtpTPs (1.5 billion), but to anticipate a very small portion of defaults (11 per cent).

Costs and benefits

Compliance with the rules of the new crisis code, in particular the fulfillment of organizational obligations, will require the Italian system of large investments: to equip itself with monitoring systems for its own risk, to acquire risk management skills (risk management), to appoint and remunerate the supervisory bodies. According to estimates based on the forecasts of a panel of professionals interviewed by Cerved, the costs amount to about 3.8 billion euros a year. In the event of a wide diffusion of treasury systems, ie with the capacity of all the capital companies to calculate the DSRC, they could rise to 6 billion euros. For a small business, the costs would be around 15-20 thousand euros a year; for an average the costs would double.

Through an analysis based in part on company data, partly on the results of the back testing exercise conducted by Cerved for the identification of the five indices, partly based on assumptions relating to three alternative scenarios, these costs were correlated with the benefits deriving from the early emergence of the crisis.

The estimates should be taken with caution, also due to the uncertainty regarding the concrete application of the new rules. It is however possible to draw some conclusions.

The success of the reform will depend crucially on how it will be received and implemented by the entrepreneurs and professionals involved. In particular, it will be important, on the one hand, a wide dissemination of treasury systems, which will allow to identify difficult situations in a timely manner and, on the other hand, an effective and efficient management of crises on the part of the Ocher. If the system will address the reform in a logic of mere formal compliance with the rules, relying exclusively on budget ratios without adapting organizational models, the costs will far outweigh the benefits: the reform will be reduced to an increase in accounting and organizational compliance with very reduced benefits in terms of recovery and crisis management.

On the other hand, in a scenario of timely application of organizational obligations, with treasury systems common to all businesses and effective crisis-settling procedures by the Overs, the benefits would be well above the costs (10 billion against 6 billion) , thanks to the ability of the system to "save" many companies from bankruptcy and to allow higher rates of asset recovery in companies, however, destined to exit the market.

The advantages of a widespread adoption of risk management systems would not be limited to the ability to intercept crises early: in fact they allow to guide the choices concerning investments and financing policies, the composition of the sources, at their cost. They are tools that make small businesses more transparent, to which banks now apply interest rates that are not correlated with their risk of bankruptcy. It is estimated that over one billion more small and micro-company loans will have an effect, which would pay less money, and a net effect on added value quantifiable in another 1.3 billion.

In other words, the crisis code offers an opportunity to formalize and digitalize SME management practices and to improve their financial culture: a qualitative leap that, to date, the business system does not seem able to do alone.

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