Finances, Debt & Analysis in the Turnaround

A company’s financial picture at any given time is vitally important to all stakeholders, and never more so than during a turnaround. Financial results are the yardstick by which the business is measured. Outside lenders, creditors, and buyers continually desire affirmation that the company is viable and will be able to continue to meet all of its obligations, including non-financial commitments. Additionally, management relies on this financial information to plan the strategies for the turnaround and future business growth.

Most financial information available has historically been of a reporting nature–it reports prior performance by means of accounting information. The assembly of reliable predictive information on a regular basis is an important step toward profitability; reports such as accounts receivable, accounts payable, cash flow projections, vendor analyses, equities, return on cash, and profits from sales must be generated.

The company’s cash position can be summed up as follows: the money in the bank plus anticipated revenues from sales and financing activities minus any expected payments for direct costs, indirect costs, and general and administrative expenses. The accounts payable portion of the cash position measures the company’s ability to pay current vendors and repay creditors for goods and services delivered. The accounts receivable position is a tabulation of expected sales and fees to be received during a given period. The difference between the two types of accounts is a quick, short-term indicator of the current financial condition of the company.

Complete listings of all bills owed and obligations accrued must be made prior to the release of monies from sales and financing activities. These bills are prioritized for payment–especially payroll, taxes, utilities, and subcontract labor. Secondary obligations are suppliers (unless sole sources), interest due lenders, retirement plan funding, leases, and equipment payments. Cash is only to be disbursed according to priority payment schedules; failure to abide by this rule, regardless of circumstances, will cause problems in restoring positive (or enhanced) cash flow and reduce the likelihood of successful implementation of the turnaround plan.

Debt Structure

A business’s debt structure dictates the profit necessary to amortize it. Accumulated debts to suppliers, lenders, and financing sources need to be determined and paid form the gross profit streams. Paying past-due accounts from loans leads to business failures. For this reason, the gross profit must be managed with extreme care. First, management must estimate the amount of money to:

  • repay creditors over a reasonable time (reasonable = 7 years for structured debt, biweekly for contract labor, monthly for suppliers, and quarterly for taxes),
  • pay creditors for the current portion (<45 days), and
  • pay past-due creditors while remaining current to maintain credibility.

Suppliers, 1099s, direct costs, and indirect costs should be paid from operating funds–not loans. General and administrative expenses should be paid from gross profits.

Creditors should be made a part of the turnaround plan. Analyze and prioritize all debts, contact them, and discuss the projected payment plan for the debt owed. Amortization schedules for their accounts need to be explained and agreed to. Input from other creditors can then be used to draft a scheduling document to complement the accounts payable plan. Taken as a whole, the schedule will aid management in disbursing funds.

Management Analysis

Accumulating data can be a time waste if not turned into timely, useful information. As marketing, operational, and financial numbers are compiled, it should form the basis of the management information system. The resulting analysis will test and challenge beliefs about the company’s competitive position. Critical assessment of trends, patterns, and tendencies can generate ideas to further one’s mission, goals, and objectives. 

Analysis and action should commence hand in hand as the return-to-growth process unfolds. Merely stabilizing is not a permanent solution, but rather a step in the process toward profitable growth. As analysis is performed, opportunities are generated by involving key personnel in problem-solving meetings on a regular basis–the team management concept. For example, a change in product quality to match buyer demand–such as reducing product size while adding features–may be an opportunity discussed in problem-solving meetings.

Why You Can’t Turn the Company Around

Yesterday, we briefly touched on three different types of turnarounds–strategic, operational, and financial. The point was also made that many successful turnarounds are a combination of more than one type. If you have never had experience determining which type fits a given situation, chances are high that you will make some mistakes than could prevent the company’s successful recovery. There are at least two other reasons the desired recovery may never be seen–procrastination and delusion. We aim to explore both of these mindsets, but first want to dive deeper into our definitions of turnaround types. 

  • Strategic – the changing of markets and products, for instance going after new segments of the market.To do so would require new strategies and tactics with regards to promotions, pricing, design features that would need to be scheduled in the turnaround plan to guide management through the remarketing of the company.
  • Operational – transforms the cost structure of the operations. Unloading aged inventory and increasing sales efforts are two examples of use of this method. The operations section of a turnaround plan discusses schedules, budgets, estimating, purchase orders, direct costs, work in process, customer service, and time and dollars to get profitable work out the door.
  • Financial – this section of the turnaround plan ordinarily addresses debt structure, debt payment, accounts payable aging, accounts receivable strategy,  cash flow, inventory turns, revenue projections, and general and administrative cost structures (among other things). The costs recorded are actual, rather than accrual or standard, due to the time constraints of a crisis situation. 

The Danger of Procrastination

Too many companies decide to “ride it out” -like a foolish person in a coastal area with a category 5 hurricane approaching. Staying in the bad situation and only wringing one’s hands about lurking danger is NOT a solution! Management paralysis extends into business operations in the form of delayed strategic decisions. Those who refuse to admit that a problem actually exists do themselves, their employees, creditors, and customer a huge disservice. 

The business continues to lose credibility and money, and the loss of credibility can incapacitate a  leader’s ability to pursue many options. Teams must, therefore, avoid any procrastination and make the decisions necessary to initiate immediate action. Any delay simply makes the turnaround that much more difficult to accomplish.

The Investor Delusion

At this point, another common delusion is that a “white knight” investor exists who will swoop in and save the company with a cash infusion. Turnaround funds are only available when a credible turnaround exists, a plan that, not surprisingly, must include a substantial return for the turnaround investor. A desirable return normally includes the following:

  1. Origination fees for fund placements: 2 to 10 percent
  2. Management fees for recovery oversight: 5 percent
  3. Equity positions (transfer of ownership via stock): 25 percent or more
  4. Redemption based on retained earnings: 3 to 4 times retained earnings

As one can see…seeking the outside investor can make an imbalanced balance sheet much worse in a hurry. Instead, it’s wiser to work with existing stakeholders: vendors, lenders, (employees) and stockholders. Focus on management–not miracles!

Facing the Problem

When the executive team owns the fact that they must find a new, viable solution and they are willing to do “whatever it takes,” a new course of action must be chosen. Three distinct options should be considered:

  • A complete and comprehensive change in modus operandi–and the implementation of accountability and controls. This almost always is a shift to more team involvement in making decisions to counteract traditional one-man rule.
  • Pursuit of a bankruptcy procedure, led by attorneys, accountants, and others to protect the company assets and try to buy time. The turnaround plan is drafted in legal and accounting language and creditors are put at bay temporarily. Everything then hinges, however, on profitable growth moving forward.
  • Retaining a turnaround advisor who has significant experience in crisis situations is often the best choice. Often, bankruptcy filings can be avoided and the cash saved used to fuel a quicker recovery.

Your choice of option must be agreed upon by the entire management team if you plan to emerge with momentum. Greater transparency than ever before will win morale points with the team and the employees, plus help restore credibility with outsiders. With hard work, tighter controls, and improved leadership, you an “right the ship!”