Most troubled companies share a common denominator: excessive debt and management indecisiveness. That doesn’t mean lack of desire to perform. It does, however, mean that there have been some fundamental issues, strategy mistakes or procrastination among senior management in the months or years leading up to that point. You could write several books on the lists of reasons that companies get into trouble and in a career of restructuring troubled companies, there are many stories to tell.
Managers need access to relevant, current financial and operating data, on a transactional level, if the company is to have a chance of success. But that’s not all. Managers must not only have access to that information, but they must also be willing and able to analyze the information correctly and employ a disciplined approach that enables them to act on the information to move the company forward.
There are 6 main areas of focus for a company in distress.
1. Cash management. Cash is the lifeblood of every company. Without cash, the company will cease to exist. Every CEO, CFO and President should demand strict controls and a reporting system for cash management. The tone is set from the top and this begins with expenditure control. A policy should be in place with a dollar limit on normal and necessary expenses that can be incurred by the designated managers. Line managers who overspend can quickly drown a company.
In stressed or distressed situations, a rolling 13-week cash forecast, along with a comparative cash flow analysis should be mandatory. In fact, a consistent rolling cash forecast should be mandatory for every company. These reports identify cash inflows from customers, debt issuers, investors and the sale or disposal of assets or business units. They also identify cash outflows from operations, to suppliers, debt service, and the purchase or investment in assets and other businesses.
In a distressed company, the cash burn rate is critical. Management must be able to accurately forecast cash flows every week, month, and quarter and report to any interim debt or equity providers and deviations from the forecast.
2. Profit and profitability (margins) come a close second to cash. In order to raise cash levels, companies need to become more profitable, in addition to raising equity and selling off assets.
Even if management raises equity or sells assets in the short term, sooner or later, it has to become more profitable. Again, the company culture or attitude starts at the top. Everyone in the company must think and act towards growing revenues, most importantly while reducing expenses.
In order to set a Gross Profit target, a manager should consider the minimum dollar amount the Gross Profit needs to be in order to cover the operating expenses, interest payment requirements, debt service requirements, and the net return expected by the shareholders. From this, they can determine the minimum required Gross Margin. If this minimum targeted Gross Margin causes sales prices to be noncompetitive, then management needs to study their business and competitors to identify the reasons why and adjust accordingly.
Comparison to a much larger competitor may identify their advantages due to size and volume in areas such as per unit manufacturing costs and increased purchasing power. Conversely, larger companies have a higher fixed cost platform to overcome, which can give them bigger challenges in times of stagnant or declining revenue.
Midsize and smaller companies need to differentiate themselves through unique features and benefits such as improved customer service and responsiveness, location, accessibility of inventory, improved technical expertise, unique products, proprietary solutions or any other added value that allows the customer to justify paying a higher price.
Other ways to improve efficiency and reduce operating expenses may include reducing the number of key management personnel that have become less productive but remain highly paid, reducing the number of locations or space to reduce overall occupancy costs, review company participation in employee benefits, evaluate services that are being outsourced or maybe should be outsourced, consider risk management alternatives to reduce insurance costs, equipment replacement costs versus high repair costs and contributing or raising capital to reduce interest costs. Dependent upon available resources and implementation, a focus on technology utilization to better meet the goals of the business can be an effective long-term tool to increase productivity and improve efficiencies while reducing expenses.
A fair return to the shareholders is required, but when shareholders have unreasonable ROI demands in a distressed environment, management may increase their debt burden or raise their prices to cover unreasonable earnings goals, which can in turn create a non-competitive product or service that will reduce revenues.
3. Controlling costs is usually the most effective and quickest method of increasing profitability in any company. Reducing manufacturing costs and inventory purchase costs, as well as reducing operating costs increases profits dollar for dollar. Conversely, a dollar increase in sales is discounted by the Cost of Goods Sold before it improves profitability.
Budgeting is the only sure method to control costs. Study the cost data and its drivers for every manufacturing, purchasing, and operating account or category. Conduct a consistent monthly evaluation of cost variances, budget to actual and study their cause and effect. Use this data for future action items or increased accuracy in planning.
Lean and efficient companies are process oriented. All repetitive tasks (actions) should be incorporated into standardized Standard Operating Procedures (SOPs) that can be measured with Key Performance Indicators (KPIs). These KPIs need to be monitored daily, weekly, and monthly to provide assurance that costs are under control. This allows for immediate action to stop the cash burn when performance is outside the acceptable range.
4. Fixed Assets and Inventory make up the largest dollar investment for most companies. Unfortunately, too many managers do not focus enough attention on the Return On these Assets (ROA). Accounting systems should be in place to report the profit earned from these assets individually and as a category.
When a management team consistently studies ROA, they will be able to determine any action that may be necessary such as reducing inventory levels, securing new outlets for excess inventory, quicker manufacturing cycles, and changing the inventory mix to increase those with higher ROA.
In respect to fixed assets, a CAPEX budget should be a component of every company’s business plan. The CAPEX budget begins with the line managers creating a list and estimated cost of new equipment (or major repairs) they believe are necessary to maintain or improve quality, service, or cost reduction through efficiency gains. Most companies only have a limited amount of funds available for CAPEX one year ahead, so the focus on ROA will target improved decision making with facility and equipment investments.
5. Accounts Receivable. The Business Cycle is not complete until you collect the money. Sales and Gross Profit can be extraordinary, but if you do not collect the money, you can’t pay the bills or make payroll.
Accounts Receivable management requires not only that a company has discipline, but also that customers pay on time. The temptation to be flexible with customers is greatest when sales are stagnant and competition is high. Management teams of many troubled companies are pursuing revenue growth so aggressively that they fail to enforce payment terms on certain customers, and they may even take on customers who are trying to avoid tough credit policies with their competitors. Guess which customers are most likely to default on their credit?
Many companies borrow against or factor their receivables to shorten their A/R turnover (sale to cash days). The importance of prompt collections does not go away. Generally, businesses can only borrow 85% of their receivables that are not more than 30 to 60 days past due. The business then incurs the interest charges and is still burdened with the delinquent dollars.
Successful companies have a strict credit policy which begins from day one with a new customer. A company’s AR discipline is a reflection of a company’s ability to deliver and perform on difficult tasks and in tricky situations. Failure to follow this discipline registers with many customers and competitors as a sign of weakness. Short-term success may be followed by long term failure if a company doesn’t adhere to strict AR collection policies.
6. Debt. In a tough business environment, too many businesses drown in debt. Companies may have industry leading profit margins, but with leveling or declining revenue growth these companies can struggle to cover their interest costs and debt service requirements. Many companies, especially start-ups and troubled companies, must determine a maximum reasonable debt burden. If they are burning cash too fast and have to float more debt or raise more capital, then it probably indicates an issue somewhere between #1 and #5 on this list. There are likely underlying issues that need to be cured.
Successful businesses have a fundamentally sound, effective, and efficient finance function. Whether a company is an early stage company or a mature company in a consolidating industry, the basic financial scorecards must be maintained and studied. Troubled companies’ management teams are usually in denial when it comes to the financial trends and scorecards.
If all of this sound likes the basics of business, it’s because it is the basics. Unfortunately, a failure to follow the basics with an intense and persistent focus often leads to failure when a company hits a bump in the road.