Insights


Many businesses that end up in receivership could have been saved if they had heeded early warning signs and sought the right assistance at the appropriate time.

This is true at any stage of the business cycle but is a particularly powerful conundrum now in the midst of the global economic crisis.

The sobering fact is that of the 10,000 to 14,000 companies this year likely to become insolvent, a significant number of them could have been saved if they had sought the right help early enough.

Recognition of this is what is driving the growth in Australia of specialist corporate turnaround advisors. Specialist turnaround advisors sit between insolvency practitioners and management consultants/corporate financiers on the business spectrum.

While the turnaround industry is mature in the US and European markets, in Australia there is a limited but growing pool of specialist turnaround management expertise.

The Turnaround Management Association of Australia consists of professionals from various disciplines committed to assisting financially stressed or underperforming businesses. It is separate from the insolvency industry and is committed to corporate renewal and insolvency prevention.

Its members are drawn from companies that focus on pure business turnaround and profit improvement as well as from the major accountancy and insolvency practices.

Globally, the association started in the United States about 20 years ago and currently has more than 8000 members in 28 countries. The Australian chapter of the TMA launched in 2005 and has more than 200 members, making Australia the third largest chapter in the world.

While the industry is top of mind in the current economic climate for “saving” troubled businesses, turnaround experts do not just work with businesses on the brink. Many clients turn to them for general profit improvement assistance.

Don’t wait until it’s too late
Companies must be willing to admit they need help. The earlier we get engaged, the more options we have to restructure the business.

This is often difficult because human nature makes it hard for people – let alone senior business people, many of whom may have created the company in trouble – to ask for help.

But calling for expert help early enough can often prevent the heartache and headache caused by leaving it too late and ending up in insolvency proceedings.

The three key elements of any turnaround are financial restructuring, operational restructuring and stakeholder management.

A turnaround practitioner is a meld of the following skills: insolvency/corporate finance/audit; management consulting/CFO; project management; negotiation and HR skills; financial modelling and report writing; as well as lateral thinking ability and the ability to stay calm under pressure.

On engagement, a turnaround management specialist will critically assess the troubled entity’s business plan and review profit and loss to determine the causes of underperformance such as loss of customers, increased competition or rising production costs.

Turnaround specialists produce and maintain a rolling 100 day work plan which details the major initiatives being undertaken to improve business performance and ensure that the initiatives are being implemented in a timely and efficient manner.
Timing is critical when a company is underperforming.

The turnaround specialist will improve cash flow, stabilize operations, communicate with key stakeholders to re-build their support, explore all strategic options and develop a comprehensive turnaround strategy.

They will conduct strategic, financial and operational reviews to identify areas of underperformance and then assist management with executing strategies to improve the overall performance of the business.

Often they will turn to their extensive network of financiers and private equity firms to introduce the right combination of debt and/or equity to fund the business.

If steps are taken early to address the causes of underperformance then appropriate measures can be put in place to provide the best possible environment in which to develop a coordinated and achievable turnaround strategy.

Warning signs to look for
Common threads amongst troubled businesses include when management has been too focused on growing revenue without considering the impact on margins and profit; if businesses don’t have the right systems and controls in place to manage their working capital; or if businesses don’t have the right management team depth of skill and don’t review financial and operational performance regularly.

These are some key warning signs:

 Working capital growth outstripping revenue growth
 Profit warnings/missing forecasts/declining margins
 General industry downturn or industry consolidation
 Actual/potential bank covenant breaches
 Loss of key management personnel or increase in staff turnover
 Management “buying” sales at the expense of margin
 Creditor or debtor ageing issues
 Competitor risk
 ATO and Super arrears
 Loss of a major customer
 Post merger integration issues
 Difficulty in obtaining general finance

Improving cash flow
Working capital – the amount of cash tied up in accounts receivable, inventory and accounts payable – will be the No. 1 issue for many businesses in the months ahead as they fight deteriorating market conditions.

Any improvement in working capital is beneficial, whether the funds are used to pay down debt, fund capital expenditure, satisfy seasonal cash requirements or further invest in research and development.

Specialist performance improvement and turnaround management firms aim to deliver strategies which rapidly improve profitability and cash flow. They work with clients to identify what drives their business, how to achieve above industry benchmarks and more importantly implement strategies that increase the financial performance and value of their business.

Deterioration in accounts receivable days or stock turnover will have serious impacts on cash flow. There are always significant opportunities to improve the current level of working capital to improve cash flow.

At Vantage Performance, our experience is that a 10%-25% improvement in working capital is achievable.

Here is an example of the level of cash that can be released:
– Average Receivables $10M (55 days/sales)
– Average Payables $7M (40 days/sales)
– Average Inventories $3M

By reducing accounts receivable collections by 5 days (or only 10%) we could improve cash flow by $1million. By increasing accounts payable by only 4 days we would improve cash flow by $0.7million. By reducing stock levels by only 10%, $0.3million cash would be released.

There are a range of strategies which can be deployed to achieve these results which could result in an improvement in cash flow of $2million or more. This “released” cash could then be used for debt reduction, capex/re-investment or return to shareholders.

As a result of making the improvement this business becomes more efficient, return on capital is increased, and management’s cash flow targets are exceeded.

In our experience, a 10% improvement tends to be at the lower end of the range achieved. Some of our client businesses have generated up to 25% improvement in their working capital – equivalent to a release of up to $4.5million in the above example.

CASE STUDY – Project Jean

Background

This successful retail group had expanded too rapidly without sufficient working capital to fund this growth. Whilst management had grown the group to 12 stores the last 6 stores had incurred significant trading losses.

Key issues

• Finance covenant breaches
• Cash flow crisis
• Bank was “under water” and refinancing was not an option
• Poor working capital management
• Lack of management depth
• Core business still viable

5 Phases

• Stabilise the business
• Strategic review and turnaround plan developed
• Close unprofitable/unsustainable outlets – stakeholder negotiation was key!
• Focus on core stores and “grind it out”
• New growth after pruning

Outcome

• Cash flow crisis averted
• Stakeholder relationships restored
• Tracking 80% + increase in same store sales
• $1.1 million improvement in net profit

Potential breakout box: What a turnaround specialist does
At Vantage Performance, these are some of the typical tasks we undertake to help turn around a troubled business:
– Establish a robust rolling 13 week rolling cash flow forecast so management can truly understand how cash flows through the business and when key flash points may arise.
– Implement systems to accurately calculate product/service profitability. Raising prices or dropping unprofitable products may need to be considered.
– Develop a strategy to keep communicating with major stakeholders (bank, key suppliers, key customers, shareholders and employees.
– Develop a marketing strategy to win new customers and so decrease any customer concentration risk.
– Look at a range of initiatives to reduce costs in the business.
– Critically assess management’s strategy as we may need to fundamentally alter the structure of the business to restore viability.
– Document a strategic business plan with detailed forecasts so the troubled business can show financiers they are working to a plan. Gaining financiers’ confidence is crucial in the current market where it is harder to raise new finance.
– Review the management team to ensure the right mix of staff with appropriate skills. Consider recruiting experienced staff to plug the gaps.
– Review processes to identify areas of labour or time wastage. Is the business really getting your products and services to market as efficiently as possible?

Our Vantage Performance team is looking forward to interacting with you again.

Regards,

Michael Fingland
Executive Director

Vantage Performance Team
Profit Improvement and Turnaround Specialists

 

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Michael Fingland

My philosophy is that there is always a way to solve a crisis, as long as you’re engaged early enough.

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Cooperative leadership teams that develop prioritised actions to progress towards clear strategic objectives can achieve long-term business viability.