THE TURNAROUND PLAN FOR A TROUBLED COMPANY
The Gestation Period of Crisis
A crisis rarely develops overnight. The time between the initial cause of trouble and the point of intervention can run from 18 months to five years. What happens to a company during the gestation period has implications for the later turnaround for the company. Thus, how management reacts to crisis and what happens to morale determine what will need to happen during the intervention. Usually, a demoralized and unproductive organization develops when its members think only of survival, not turnaround, and its entrepreneur has lost credibility. Further, the company has lost valuable time.
Generally, when an organization is in troublesome tellable trends appear:
Ignore outside advise.
The worse is still yet to come.
People (including and usually, most especially, the entrepreneur) have stopped making decisions and also have stopped answering the phone.
Nobody in authority has talked to the employees.
Rumours are flying.
Inventory is out of balance.
Accounts receivable ageing is increasing.
Customers are becoming afraid of new commitments.
A general malaise has settled in while a still high-stressed environment exists (an unusual combination).
The decline in Organizational Morale
Among those who notice trouble developing are the employees. They deal with customer returns, calls from creditors, and the like, and they wonder why management does not respond. They begin to lose confidence in management.
Despite troubled times, the lead entrepreneur talks and behaves optimistically or hides in the office declining to communicate with either employee, customers, or vendors. Employees hear of trouble from each other and from other outsiders. They lose confidence in the formal communication of the company. The grapevine, which is always exaggerated, takes on increased credibility. Company turnover starts to increase. Morale is eroding.
It is obvious there is a problem and that it is not being dealt with. Employees wonder what will happen, whether they will be laid off, and whether the firm will go into bankruptcy. With their security threatened, employees lapse into survival mode. As an organizational behaviour consultant explains: “The human organism can tolerate anything except uncertainty. It causes so much stress that people are no longer capable of thinking in a cognitive, creative manner. They focus on survival. That’s why in turnarounds you see so much uncooperative, finger-pointing behaviour. The only issue people understand is directing the blame elsewhere (or in doing nothing).”
A crisis can force intervention. The occasion is usually forced by the board of directors, lender, or law-suit. For example, the bank may call a loan, or the firm may be put on cash terms by its suppliers. Perhaps creditors try to put the firm into involuntary bankruptcy. Or something from the outside world fundamentally changes the business environment.
The Threat of Bankruptcy
Unfortunately, the heads of most troubled companies usually do not understand the benefits of bankruptcy law. To them, bankruptcy carries the stigma of failure; however, the law merely defines the priority of creditors’ claims when the firm is liquidated.
Although bankruptcy can provide for the liquidation of the business, it also can provide for its reorganization. Bankruptcy is not an attractive prospect for creditors because they stand to lose at least some of their money, so they often are willing to negotiate. The prospect of bankruptcy can also be a foundation for bargaining in a turnaround.
Intervention
A company in trouble usually will want to use the services of an outside advisor who specializes in turnarounds.
The situation the outside advisor usually finds at the intervention is not encouraging. The company is officially technically insolvent or has a negative net worth. It may already have been put on a cash basis by its suppliers. It may be in default on loans, or if not, it is probably in violation of loan covenants. Call provisions may be exercised. At this point, as the situation deteriorates more, creditors may be trying to force the company into bankruptcy, and the organization is demoralized.
The critical task is to quickly diagnose the situation, develop an understanding of the company’s bargaining position with its many creditors, and produce a detailed cash flow business plan for the turnaround of the organization. To this end, a turnaround advisor usually quickly signals that change is coming. He or she will elevate the finance function, putting the “cash person” (often the consultant himself) in charge of the business. Some payments may be put on hold until problems can be diagnosed and remedial actions decided upon.
Diagnosis
Diagnosis can be complicated by a mixture of strategic and financial errors. For example, for companies with large receivables, questions need to be answered about whether receivables are bloated because of poor credit policy or because the company is in a business where liberal credit terms are required to compete.
Diagnosis occurs in three areas: the appropriate strategic posture of the business, the analysis of management, and the “numbers.”
Strategic Analysis
This analysis in a turnaround tries to identify the markets in which the company is capable of competing and decide on a competitive strategy. With small companies, turnaround experts state that the most strategic errors relate to the involvement of firms in unprofitable product lines, customers, and geographic areas.
Analysis of Management
Analysis of management consists of interviewing members of the management team and coming to the subjective judgement of who belongs and who does not. Turnaround consultants can give no formula for how this is done except that it is a result of judgement that comes from experience.
The Numbers
Involved in the “numbers” is a detailed cash flow analysis, which will reveal areas of remedial action. The task is to identify and quantify the profitable core of the business.
Determine available cash
The first task is to determine how much cash the firm has available in the near term. This is accomplished by looking at bank balances, receivables (those not being used as security), and the confirmed order backlog.
Determine where the money is going
This is a more complex task than it appears to be. A common technique is called sub-account analysis, where every account that posts to cash are found and accounts are arranged in descending order of cash outlays. Accounts then are scrutinized for patterns. These patterns can indicate the functional areas where problems exist. For example, one company had its corporate address on its bills, rather than the lock-box address at which cheques were processed, adding two days to its dollar days outstanding.
Calculate per cent-of-sales ratios for different areas of a business and then analyse trends in costs.
Typically, several of the trends will show flex points, where relative costs have changed. For example, for one company that had undertaken a big project, an increase in the cost of sales, which coincided with an increase with capacity and in the advertising budget, was noticed. Further analysis revealed this project was not producing enough in dollar contribution to justify its existence. Once the project was eliminated, excess capacity could be reduced to lower the firm’s break-even point.
Reconstruct the business
After determining where the cash is coming from and where it is going, the next step is to compare the business as it should be to the business as it is. This involves reconstructing the business from the ground up. For example, a cash budgeting exercise can be undertaken and collections, payments, and so forth determined for a given sales volume. Or the problem can be approached by determining labour, materials, and other direct costs and the overhead required to drive a given sales volume. What is essentially a cash flow business plan is created.
Determine differences
Finally, the cash flow business plan is tied into proforma balance sheets and income statements. The ideal cash flow plan and financial statements are compared to the business’s current financial statements. For example, the proforma income statements can be compared to existing statements to see where expenses can be reduced. The differences between the projected and actual financial statements form the basis of the turnaround plan and remedial actions.
The most commonly found areas for potential costs/ improvements are these:
Working capital management, from order processing and billing to receivables, inventory control, and of course, cash management.
Payroll.
Overcapacity and underutilized assets.
More than 80 per cent of potential reduction on expenses can usually be found in a workforce reduction.
The Turnaround Plan
The turnaround plan not only defines remedial actions but because it is a detailed set of projections, it also provides a means to monitor and control turnaround activity. Further, if the assumptions about unit sales volume, prices, collections, and negotiating success are varied, it can provide a means by which worst-case scenarios – complete with contingency plans – can be constructed.
Because short-term measures may not solve the cash crunch, a turnaround plan gives a firm enough credibility to buy time to put other remedial actions in place. For example, one firm’s consultant could approach its bank to buy time with the following: By reducing payroll and discounting receivables, we can improve cash flow to the point where the firm can be current in five months. If we are successful in negotiating extended terms with trade creditors, then the firm can be current in three months. If the firm can sell some underutilized assets at 50 per cent off, it can become current immediately.
The turnaround plan helps address organizational issues. The plan replaces uncertainty with a clearly defined set of actions and responsibilities. Since it signals to the organization that action is being taken, it helps get employees out of their survival mode. An effective plan breaks tasks into the smallest achievable unit, so successful completion of these simple tasks soon follows and the organization begins to experience success. Soon the downward spiral of organizational morale is broken.
Finally, the turnaround plan is an important source of bargaining power. By identifying problems and providing for remedial actions, the turnaround plan enables the firm’s advisors to approach creditors and tell them in a very detailed fashion how and when they will be paid.
If the turnaround plan proves that creditors are better off working with the company as a growing concern, rather than liquidating it, they will most likely be willing to negotiate their claims and terms of payment. Payment schedules can then be worked out that can keep the company afloat until the crisis is over.
Long-Term Remedial Actions
If the turnaround plan has created enough credibility and has bought the firm time, longer-term remedial actions can be implemented. These actions will usually fall into three categories:
Systems and procedures
Systems and procedures that contributed to the problem can be improved, or others can be liquidated.
Asset plays
Assets that could be liquidated in a shorter time frame can be liquidated. For example, real estate could be sold. Many smaller companies, particularly older ones, carry real estate on their balance sheet at far below market value. This could be sold and leased back or could be borrowed against to generate cash.
Creative solutions
Creative solutions need to be found. For example, one firm had a large amount of inventory that was useless in its current business. However, it found that if the inventory could be assembled into parts, there would be a market for it. The company shipped the inventory to Jamaica, where labour rates were low, for assembly, and it was able to sell very profitably the entire inventory.
Many companies – even companies that are insolvent or have negative net worth or both – can be rescued and restored to profitability.
