Definition
Internal reconstruction refers to the process of making adjustments to a company’s operations, structure, or debt to overcome financial distress without changing the business’s legal structure. On the other hand, external reconstruction involves the complete restructuring of a company’s business affairs by transferring its assets and liabilities to a newly formed company. Essentially, internal reconstruction is a make-over of an existing business, while external reconstruction is more like creating a new entity from an old one.
Key Takeaways
- Internal Reconstruction is all about a complete overhaul of a firm’s operations, capital structure, or other financial processes from within the organization. It is usually preferable when the issues can be solved in-house and does not require the company to go into liquidation. This type of reconstruction is typically aiming at reducing losses, increasing revenues, enhancing efficiency, or restructuring a company’s debts.
- External Reconstruction is a strategy that involves a company undergoing significant changes, like mergers, acquisitions, or other trade deals. This is often used when there are more complex problems within the company that cannot be resolved internally. In situations of external reconstruction, one or more companies are liquidated, and a new entity is formed to take over the assets and liabilities.
- The primary difference between Internal and External reconstruction is based on their mode of operation and the circumstances that warrant their application. Internal reconstruction is more about internal adjustments, while external reconstruction involves external elements such as merging with or acquiring another company. The choice between these two can greatly affect a company’s future direction, corporate image, and business strategy.
Importance
The finance terms Internal Reconstruction and External Reconstruction are important because they refer to strategies utilized by companies to improve their financial stability and business prospects. Internal Reconstruction is when a company restructures its business operations or finances without changing its legal entity, such workflows, processes, or downsizing.
It aims to streamline operations, cut costs, or improve efficiency internally. On the other hand, External Reconstruction is a method where a new company is formed to take over the existing company, often involving significant changes such as mergers, acquisitions, divestments, or liquidations.
This is primarily used when a company is in severe financial distress and needs to reorganize its capital structure, or when it aims to gain a competitive advantage through expansion or diversification. Understanding these terms is crucial for corporate decision-making and strategic planning.
Explanation
Internal and external reconstructions are strategic measures taken by companies to enhance their operating efficiency, profitability, and sustainability. The core purpose of Internal Reconstruction is to overhaul the company internally without affecting its legal identity. It involves reshuffling its capital structure, revaluating its assets and liabilities, eliminating any fictitious assets, and managing profits and losses.
This is typically used by companies to cut down losses, improve profitability, streamline the internal processes and rejuvenate their financial health. Furthermore, it is often the preferred method for companies looking for a turnaround, as it doesn’t necessarily involve any change in the ownership or control of the company. On the other hand, External Reconstruction is a restorative strategy that involves the formation of a new entity to take over the existing one.
The existing company is liquidated, and its business is transferred to the new entity. The primary purpose of External Reconstruction is to wipe out past losses, restructure the capital and start afresh. The new entity can have a new ownership structure or the existing owners can continue by acquiring shares in the newly formed entity.
This type of restructuring is typically used when the internal reconstruction strategy doesn’t help a company revive from a financial distress and when companies want a fresh start, free from the constraints of past mistakes and poor choices. In short, this method helps companies to overcome their financial struggles and pave a way for steady growth and improved profitability.
Examples of Internal Reconstruction vs External Reconstruction
Internal and External Reconstruction in finance are strategies used by companies to improve their operations, often following financial issues like insolvency.Internal Reconstruction Example: Eastman Kodak Company In January 2012, Eastman Kodak filed for Chapter 11 bankruptcy after struggling to adapt to the digital revolution and competition from other giants like Sony and Canon. After filing for bankruptcy, the company decided to focus on internal reconstruction and brought about changes in its business model, focusing more on its printing services and less on digital cameras. Pixpro cameras, less preferred by the market, were discontinued, and internal resources were diverted to printing and enterprise services. The company eventually emerged from bankruptcy in September
External Reconstruction Example: T-Mobile and Sprint Merger In the 2020 merger of T-Mobile and Sprint to form “New T-Mobile,” the restructuring can be classified as external. Two financially struggling entities, T-Mobile and Sprint, combined to form a new entity in an effort to provide a better mobile and internet service provider. After the merger, they emerged as the third-largest mobile carrier in the U.S. This also helped them share the cost of 5G expansion.Both Internal and External Reconstruction: General Motors General Motors (GM) underwent both internal and external restructuring after declaring bankruptcy in
Internally, they underwent a significant cost-cutting exercise by closing several factories and franchises, and focusing on just four main brands: Chevrolet, Cadillac, Buick, and GMC. GM also underwent an external reconstruction with the US treasury who invested $5 billion, buying company’s shares and debt to assist it financially. The majority of these shares were consequently sold off by the US treasury by
GM re-emerged from bankruptcy stronger and more competitive, demonstrating the effectiveness of combining both internal and external reconstruction.
FAQs on Internal Reconstruction vs External Reconstruction
What is Internal Reconstruction?
Internal Reconstruction is a strategy utilized by companies to overhaul their financial structure while continuing their ongoing operations. This might include reducing unnecessary expenditure, restructuring debt, or rearranging the real estate portfolio. The main goal of internal reconstruction is to improve the economic efficiency of the company without affecting the everyday functions.
What is External Reconstruction?
External Reconstruction happens when a financially troubled company decides to sell its business to another company. The old company is formally liquidated, and a new company is formed which takes over the business. It is essentially the financial restructuring of the entire company using methods like mergers, takeovers, or buy-outs.
What are the benefits of Internal Reconstruction?
Internal Reconstruction offers several benefits including an improved balance sheet due to debt restructuring, the potential for increased profitability due to reduced costs, and generally improved business efficiency. It also gives the company the opportunity to refocus its strategies and missions on the most profitable areas of business.
What are the advantages of External Reconstruction?
External Reconstruction allows for a broader range of restructuring options, such as blending different company cultures, products or strategies. It can potentially bring new customers, markets, or resources that were previously inaccessible. It also allows the company to eliminate competition through consolidation.
Which one should a company choose: Internal Reconstruction or External Reconstruction?
Both types of reconstruction come with their own sets of benefits. The choice between Internal Reconstruction and External Reconstruction largely depends on the specific circumstances and financial health of the company in question. It makes sense to consider internal reconstruction if the company’s operations are sound but just need some financial reorganization. External reconstruction may be a better choice if the company is in a more severe financial situation, its market has dramatically changed, or there are significant opportunities for consolidation with another company.
Related Entrepreneurship Terms
- Corporate Restructuring
- Balance Sheet
- Liability Reduction
- Mergers and Acquisitions
- Shareholder Rights
Sources for More Information
- Investopedia: This website provides a wealth of information on various finance terms and concepts, including internal and external reconstruction.
- AccountingTools: This website can provide detailed explanations and examples of financial terms and concepts, which may include internal and external reconstruction.
- Corporate Finance Institute: This institute offers a range of resources related to corporate finance, which includes topics like internal and external reconstruction.
- IGI Global: This publisher of scholarly research provides a wealth of academic resources related to business and finance, and it will likely have information on internal and external reconstruction.
