A crisis is pending. The company's constituents—creditors, shareholders and perhaps even employees—are pounding on the table. Borrowing to manage a cash-flow problem is no longer a possibility. As part of a forbearance agreement with the company's creditors, the bank has requested an outsider's viewpoint. Bank officials want to see better numbers and, above all, an operational turnaround plan.

This situation is more common than one may think. The fact is that banks are often misunderstood. They accept a measured level of risk in exchange for a small return in the form of interest. Banks are not playing for the "home run" like the equity player is. The equity participants (owners) have accepted a higher level of risk because they expect a higher level of return. Naturally, when there is a "hole in the company's cash flow," differing views between creditors and equity-holders collide.

Banks and other creditors want credible numbers to monitor, showing an upward trend. But it is axiomatic that improved, accurate numbers are only the result of improved sales and operations. This article outlines the steps needed to move from insolvency to a sound operational plan.

Create the Turnaround Plan

Too often a crisis has been reached because of denying obvious facts. Challenge this denial by developing meaningful tracking mechanisms based on the nature of the business.

Create a "scorecard" using basic metrics such as cash flow, rather than managing on an income-statement basis. Margin is still important, but making the business cash-positive is crucial. Understand the economics of the business, such as fixed costs, overhead, contribution margins, sales forecasts, key suppliers and customers. Develop a conservative baseline budget to help major constituencies, such as the bank, board of directors and shareholders, measure performance.

Compare performance figures with industry averages. Establish "red flags" to alert management as soon as the scorecard shows a problem. Develop enough data sources to pinpoint areas of concern and respond quickly and appropriately.

Understand the most important priorities that halt a downward spin, such as selling more products, raising prices, liquidating a division or laying off part of a workforce. Convince management that these steps are essential to restoring the health of the corporation. When the survival of the corporation is in question (not to mention the honoring of its debts to creditors), pragmatism comes before sentiment.

Build a team of personnel to execute the program. Weed out any troublemakers, and find the stars that want to rise to the challenge. Seek answers from middle management that may have been hampered in executing their ideas.

Finally, establish credibility to buy the time needed to build on this success. When creditors believe a turnaround will occur, this is when they're willing to provide the time for it to occur.

Manage Denial

Bankers are not in the liquidation business, nor do they make loans with the expectation that debtors will go into liquidation. However, bankers will "push the envelope" and stretch to stay competitive, thus increasing their risks. While banks may attempt to recoup losses through the workout process, by the time a customer is insolvent, they have clearly failed in their efforts.

Still, there likely will be the need for denial management by both the company and its creditors. These relationships are often built on friendships that extend from the boardroom to the country club. Both borrowers and creditors are often guilty of failing to use "best practices." The turnaround consultant is helpful here in addressing past mistakes made by both the company and its bank.

Understand the Customer's Needs for Products and Services

The turnaround consultant can bring a fresh, unfettered perspective to the customer's valuation of products and services, including competitive factors such as innovation, timeliness, quality or cost. Keeping the customer base intact and growing means a greater likelihood of obtaining cash. Cash buys the company time. Cash gives the company options, such as paying down debt or investing for the next round of customer sales. Cash always talks, but in a turnaround crisis its voice is loud and clear.

Scrutinize Basic Tasks Involving Products or Services

The famous quote from Henry David Thoreau are the bywords of the turnaround consultant: "Simplify, simplify, simplify." Begin by reducing the business to its most basic elements:

• Build it (manufacture, conceptualize).
• Sell it, or provide it (product or service).
• Bill it (invoicing).
• Collect it (accounts receivable).
• Report it (tracking the sale).
• Communicate it (results to management).

The challenge for the turnaround consultant is to see past the noise and chaos of the situation to the simplest elements of what needs to be done operationally to sustain a business. Experienced consultants are not frozen into inaction by even the most challenging situations. They have brought companies past the brink, back to solvency, and recognize that insolvency is only operations with "negative number signs."

What to Expect and What Not to Expect When Matters Go Awry

Companies in demise are known for "chasing the dream." Owners get caught up in believing that somehow, some way, business will get better given a bit more time. Usually, however, it is a continued downward spiral.

Don't wait for good luck to turn matters around. In fact, expect an uphill battle. Personal interests and biases often get in the way of better judgment. Expect a lack of the right mix of people to accomplish the turnaround, as well as a lack of support from the board. Addressing this apathy early on is best, because these attitudes are often fatal to any turnaround effort.

The Need to "Get Beneath the Numbers"

There is an old saw that accountants use numbers as drunks use lampposts: for support rather than illumination. A normal collateral audit, for example, doesn't flush through problems involving the quality of inventory or receivables. Unless an audit gets past the numbers by looking at the actual liquidation value of inventory or receivables, decapitalization can occur at the next bend in the road. Further, a typical auditor is not in a position to judge if circuitboards represent quality inventory that can be sold for 100 cents on the dollar, or quality control failures that must be written off at a substantial loss.

One company was almost immediately decapitalized when it was forced to recognize that, due to quality-control problems, more than half of its inventory was not saleable. On the verge of selling itself to another firm for a handsome profit, it went from being courted to liquidation in bankruptcy court.

Receivables from companies that are themselves insolvent may need to be written off. While it may take the Financial Accounting Standards Board (FASB) years to settle the terms of what does or does not represent an independent audit, a turnaround consultant is now mandated to cut through the dross, find the company's true value and represent that value as independently and objectively as possible to creditors and investors. Through this credibility, the company may gain the time it desperately needs to find a sound footing and regain its strength.

Ingredients in Successful Turnarounds

Actions that are most likely to bring success to a struggling company include:

• Realizing there is no person with all the answers, but, as a team, management can overcome many challenges.
• Collecting multiple data points to understand the situation (talk to as many people as possible) before reaching any conclusions.
• Looking for independent collaborative information that may point you in the same direction.
• Continuously questioning strategies, issues and tactics.
• Looking for new and creative ways to use existing resources at hand (e.g., turning excess and old inventory into cash).
• Seeking out "voiceless" employees on-site who may have answers and insights.
• Enforcing action, creating a sense of urgency and focusing management on tasks that are new primary objectives (e.g., collection of receivables).
• Getting people to buy into the turnaround team and a "new vision."
• Challenging management, ownership and the board of directors into addressing sacred cows, such as entitlements, the roles of family members or historically rooted strategies and tactics.
• Building consensus for making changes.
• Driving toward the best outcome possible and accepting the need for alternatives such as sale of the business, recapitalization or liquidation.

When the Clock Is Ticking

The situation is daunting. Time is running out, creditors' patience is finite and the turnaround consultant has less than complete control of the environment. These are the times when knee-jerk reactions could kill a company. However, crisis management can help avoid that outcome by:

• creating financial controls,
• building constituencies,
• understanding customer needs, and
• identifying and communicating a new operational plan.

The result is earned credibility, which can build success.

These guidelines help create success, but there is no simple formula for managing a turnaround. Answers may be hidden in plain sight, or the board itself may be the primary obstacle to success. Every situation is unique. The only reliable advantage is that it's rarely in the stakeholders' interest to see a business fail. There is also one reliable rule: The solution lies behind the numbers, in the heart of a company's operations.

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Footnotes

¹ David E. Mack is a managing director of ALTMA Group LLC, a turnaround and restructuring consulting firm with regional headquarters in Northfield, Ill. (Chicago) and other regional offices across the United States. He has a diverse background as a CEO, CFO, Chief Restructuring Officer, operating executive, financial executive and investment banker. For further information, please call (336) 275-9110 or visit http://www.altma.com. Return to article