What are Non-Performing Assets?
Non-performing assets are assets that are not performing well and have a negative impact on the company’s financial performance. These assets include physical, intellectual and intangible property.
Non-performing assets, or NPAs, are assets that have not been generating cash flow. They are written off by the company and are not expected to be recovered.
In the past few years, non-performing assets have been in the news more than ever before because of the global economic recession and its impact on businesses and governments around the world. The four main reasons why non-performing assets are a problem are:
- They create a shortage of capital and low levels of economic growth.
- The debt cannot be repaid, leading to losses for investors, lenders and companies in general.
- Non-performing loans can have massive knock-on effects on other businesses or financial institutions.
- They are uncollectible and have a negative effect on the economy, causing inflation and cutting the value of money.
Characteristics of Non-Performing Assets (NPAs)
A Non Performing Asset is a company that has been in the market for a long time but has not been able to make any significant changes. NPA’s can be difficult to identify. There can be various bases for identifying an asset as a non-performing asset. Some of the characteristics of Non-Performing Assets are:
- They have been in the market for over 10 years and the asset has been sitting idle for an extended period of time.
- They have no clear vision of the future and are not able to adapt to changing markets.
- They have no clear strategy for growth and expansion.
- They are unable to generate sufficient revenue or profits.
- The asset has been in operation for a long period without any significant improvement.
- NPAs are difficult to manage and control.
- The asset has been undergoing repair or maintenance for an extended period of time
Possible Reasons for Non-Performing Assets
An asset can be a non-performing asset for various reasons. There are multiple factors which affect the quality of the assets. The reasons could be internal or micro or it could be external or macro. Some of the reasons for such NPAs in the market are:
- Business losses due to change in market conditions
- Diversification of funds and resources to unrelated business
- Global, regional, or national financial crises can result in erosion of margins and profits of companies, which ultimately leads to non-servicing of interest and loan payments
- The general slowdown of the entire economy due to liquidity, credit crunch and other economic factors
- The slowdown in specific sectors that contribute majorly in the national economy
- Unplanned expansion of corporate houses during the boom period. Loans taken at low interest circulates at higher interest in the market, resulting in NPAs
- Mal-administration and malpractices by the corporations and business houses
- Mis-governance and policy paralysis by the regulators and authorities
- Bad lending practices by financial institutions and related authorities.
- Unanticipated natural damages like pandemic outbreak, natural calamities etc
- Cheap import due to dumping leading to business loss of domestic companies.
Impacts of Non-Performing Assets
Non-performing assets are particulars of greater interest in an economy. They directly impact the economy and NPAs reflect the condition of the economy. Some of the direct impacts of NPAs in a market are:
- NPAs lead to lower profit margins for lenders.
- NPAs are major reasons for stress in the banking sector. It clearly impacts liquidity and credit position in the market.
- NPAs result in increase in interest rate by the banks affecting the margin of the bank.
- NPAs affect the lending sector which means, NPAs affects the good projects and other capital investment.
- Non performing assets freeze investment, making projects fail, companies go bankrupt and employees losing jobs.
- NPAs stresses the balance sheet of both the financial institutions and corporate sectors.
Classification of Non-Performing Assets (NPAs)
There are various ways of classifying non-performing assets. The definition of non-performing assets is different for different businesses at different levels. Thus, classification of NPAs is different at different rational. Some of such classifications are presented below.
Dead Assets and Live Assets
Non-performing assets are usually classified into two types:
- Assets that are no longer needed because the business has discontinued or restructured the product or service.
- Assets that have become obsolete and are no longer useful to the company.
The first type is often referred to as “dead” assets, while the second type is often referred to as “live” assets.
Financial, Operational and Non-financial NPAs
- Financial NPAs : Financial NPAs include receivables, inventories, payables and prepaid expenses.
- Operational NPAs : Financial NPAs include receivables, inventories, payables and prepaid expenses. Operational NPAs include fixed assets and intangible assets such as goodwill.
- Non-financial NPAs : Non-financial NPAs include goodwill and other intangibles such as patents and trademarks.
Overexposed Assets and Underexposed Assets
- Overexposed Assets : These assets have been marketed extensively and will not generate any revenue for a long time. They are usually expensive to maintain as well and require large amounts of staff to manage them.
- Underutilized Assets : These assets may have been forgotten by consumers or they may be difficult to market due to their uniqueness or complexity. They may also be difficult to sell due to their lack of relevance in today’s market.
Tangible NPAs and Intangible NPAs
- Tangible Assets : These are physical assets like buildings, equipment, inventory, and accounts receivable.
- Intangible Assets : These are intellectual property such as patents, trade secrets, copyrighted material, and goodwill.