Lessons from Troubled Companies - Part 1

Turmoil in the Credit Markets may have a much broader impact on companies than most people imagine. From defaults on loan covenants and worsened terms for debt financing to reduced sales from nervous consumers, ongoing business operations are going to be tough for many companies.

If you are called in to rescue a company in distress, the first rule is to get back to basics. Each situation is different, but the common denominator in most distressed companies is poor management practices. That doesn't mean lack of effort, desire or motivation to perform. It does, however, mean that there have been some fundamental errors in judgment, strategy and decision-making in the years leading up to that point.

Managers must have access to relevant, current financial and operating information if the company is to have any chance of success. But that's not all. They must not only have access to that information, but they must be willing and able to analyze the information correctly and employ a disciplined approach which enables them to act on the information to move the company forward and/or protect it from distress.

You could write several books on the lists of reasons that companies get into trouble and in a long career of restructuring troubled companies, there are many stories to tell. To start with, though, over the next few weeks, we're going to bring you 2 lessons each week that will go a long way to ensuring business success.

LESSON 1 - CASH MANAGEMENT

Cash is the lifeblood of every company. Without cash, the company will cease to exist. Every CEO and CFO should demand a strict control and reporting system for cash management. No excuses. The tone is set at the top and begins with expenditure control. A policy should be in place with a dollar limit on normal and necessary manufacturing and operating expenses that can be incurred by the designated managers. Line managers overspending will quickly drown a company.

In distressed situations, a rolling 13-week cash forecast, along with a comparative cash flow analysis is mandatory. In fact, a consistent rolling cash forecast should be mandatory for every company.

These reports should identify cash inflows from customers, debt issues and investors, and the sale or disposal of assets or business units. You need to identify cash outflows from operations, to suppliers, debt service, and the purchase or investment in assets and other businesses.

If the company has more cash flowing out than flowing in, you are "burning cash".

If the company is a start-up or troubled company, the cash burn rate is critical. Management must know how much cash the company expends every week, month, and quarter. It is their responsibility to ensure that cash expenditure is within projected budgets given to Investors and Lenders. Remember, they made their decision to fund your company based on your business plan.

LESSON 2 - PROFIT AND PROFITABILITY

Profit and profitability (margins) come a close second to cash. In order to increase cash levels, companies become profitable or increase profitability, increase equity in the form of debt or capital issues, and sell off assets.

Even if management exercises one of the latter two options, sooner or later, if the company wants to be a successful enterprise, it has to become profitable. Again, the company culture or attitude starts at the top. Everyone in the company must think and act towards growing sales and revenues, and reducing costs.

Gross Profit is the amount of sales dollars left after the costs of the product or service. In order to set a Gross Profit target, you 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, you can work out what the minimum Gross Margin needs to be. If this minimum targeted Gross Margin causes the sales prices to be noncompetitive, then management needs to study their business and competitors to identify the reasons.

Comparison to a much larger competitor will 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 will give them bigger challenges in times of stagnant or declining revenue.

Mid size and smaller companies need to differentiate themselves by unique features and benefits such as location, breadth and depth of inventory, improved technical expertise, customer service and responsiveness, unique products, or any other added value that allows the customer to justify paying a higher price.

Management needs to continually evaluate ways to improve efficiency and reduce operating costs. These 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, replacement versus high repair costs on machinery and equipment and contributing or raising capital to reduce interest costs. Today's successful business leaders will dedicate resources to technology utilization which has proven to be an effective tool to increase productivity and improve efficiencies while reducing operating costs.

A fair return to the shareholders is required, but when shareholders have unreasonable ROI demands, management may increase their debt burden, raise their prices to cover debt service requirements and these unreasonable earnings goals which create a non-competitive product or service that will reduce sales and revenues as customers are unwilling to pay the higher price.

Successful business managers constantly study and compare their company to its competitors in product or service offerings which include pricing structures, gross margin percentage, operating costs as a percentage of revenue and actual dollar amount, and operating income (usually EBITDA) as a percentage of revenue.

ClearRidge provides Merger & Acquisition, Restructuring and Corporate Finance services advice for midsize companies.

M&A includes buyer and seller representation for companies with $2 million to $25 million in EBITDA and $10 million to $500 million in revenues.

Restructuring includes financial, operational, strategic and pre-Sale restructuring.

Corporate Finance includes raising and replacing senior debt, subordinated debt, mezzanine and equity financing.

Bankruptcy and Turnaround services include debtor and creditor advisory, bankruptcy support and turnaround management.

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