Erich Stolz

Building on a very successful International Management career in several corporations, Erich has concentrated on helping companies to provide the foundation to grow, turning around or restructure.  Read more...

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Lessons For Healthy Companies From The Turnaround Trenches

Lessons For Healthy Companies From The Turnaround Trenches

Today's managers would be wise to think like turnaround professionals because the gap between a healthy and an underperforming company is very narrow.

As a matter of fact, most turnaround situations could have been avoided by early intervention.  Selling an underperforming business, securing new financing when the company was still creditworthy, questioning a glowing sales forecast, efficiently integrating a new acquisition—all are missed opportunities that have pushed once healthy companies onto the slippery slope toward insolvency.

The boom years that hid performance issues are a distant memory.  Today, every penny of earnings must be made the hard way: through astute management.  Many executives who looked so capable during the good times now face a challenge they have never seen before or been trained to handle—building profitable businesses in an adverse environment.

A key concept to remember when managing in the gap between underperforming and distress is: time is not your friend! The options available to fix performance problems decrease exponentially and the severity of action needed increases rapidly as a company travels the continuum from health to underperformance to crisis.

Lessons For Success

Here are five lessons for success from the turnaround trenches that can help companies—whether healthy, underperforming or crisis-bound—stay on the right side of the gap.

1) What You Know Counts. It seems obvious, but it is surprising how often management and directors are completely unaware of their company's liquidity position.  So even though this cardinal rule in the turnaround business may seem simple, companies continue to go out of business because they run out of cash and credit unexpectedly.

Few of today's executives have seen, let alone successfully managed through, a real financial crisis.  The typical finance curriculum of various business schools teaches cash management using projections of profit and loss plus or minus changes in balance sheet items.  That's close enough for healthy companies that can assume that good performance will provide sufficient cash flow to support the needs of the business or to borrow needed funds.  But for troubled companies, this method is imprecise and can lead to an unexpected crisis.

Almost every company in a cash crunch gets there because sales fall, fixed costs remain high, working capital is not managed, and they have too much capacity.  The company misses its projections significantly, causing its lenders and the credit markets to lose confidence in management and to tighten credit terms and lower credit ratings.  Unfavorable cash flow also leads to broken promises of payments to vendors and creditors—in turn leading to accelerated demands from the creditors, which results in an even tighter cash position.  It becomes a desperate downward spiral.

2) Recognize The Value Of Cash Management As A Business Tool. An effective cash management system is based on a highly accurate plan of actual receipts and disbursements, which is quite different from accrual accounting.  In fact, accrual accounting often obscures cash flow.  Inventory, payables, and other profit and loss items are subject to enough GAAP interpretation that the consolidated financial statements of many companies do not reflect the real financial condition.

Without an understanding of cash flow, management and the board may have a misplaced sense of security based on a misreading of a company's financial statements.  To avoid being misled, a wise board and skilled management team should have a cash management plan with an accurate cash forecast based on receipts and disbursements.  True cash management works by actively managing and making decisions about each of the line items of a company's weekly, or even daily, receipts and disbursements.

What kinds of tools are best to manage cash? A 13-week detailed cash flow statement is critical, but not something most accounting systems routinely supply.  Another tool is a longer-term cash forecast, not only based on profit and loss projections and changes in working capital, but also showing major debt and capital expenditures.  More important than having the tools is using them: the board and management must monitor cash closely enough to see a problem coming.

In healthy companies, a weakening liquidity position is a symptom of something needing attention.  The factors that cause a dire financial crisis begin to stir early.  Sales may be softening, fixed costs can be out of alignment with revenues, working capital is not being managed properly, or capacity is too high.  The same processes used in turnaround situations—tight cash management and rigorous cash forecasts—can alert management in healthy companies to the early symptoms of weakening liquidity when it is much simpler to fix and there are more alternatives available.

3) Don't Rely Solely On The Numbers. By the time you see the numbers, you already may be behind the eight ball.  The time lag between events and their financial reporting can be sufficient enough to be damaging.  The tricky part is learning to recognize events early enough to act upon them.

Turnaround experts have many alternative ways to measure business performance beyond financial reports.  Several of them include: defections of key executives, industry corrections, significant regulatory changes, creeping bureaucracy, product development delays, lagging performance versus peers, bloated inventory, decreased employee productivity, product recalls, and increased customer complaints.  Skilled leaders see these events as early warning signs that something in the organization is in need of improvement, and they take immediate and effective action to correct the problem.

Make certain that the company's information systems are measuring the right things.  Poor information systems and weak financial controls obscure symptoms and hide their causes.  In troubled companies, the lack of information is not only a cause of the crisis, but a major hurdle to the company's turnaround.  In healthy organizations, poor information systems allow a progressive weakening in the organization that can go undetected until it is too late.

4) Apply A Turnaround Mentality. Even the healthiest company has a process, a division, or a customer relationship that can be repaired.  Find it.  Fix it now.  Every company should always have something in turnaround mode.

Continuous improvement is more than a process; it's a mindset that keeps a company in the peak of health.  This is not to suggest that all companies put themselves in a crisis mode at all times.  That would be destabilizing and would yield diminishing returns.  Instead, companies should look at individual pieces of the business—units, functional departments, or regions—that might benefit from the laser-sharp focus of turnaround mentality.

This mindset sends the message of continuous improvement throughout the entire organization.  More importantly, it builds the organization's capability to perform turnarounds, so when the early symptoms of distress do show up, the organization and management have already developed skills to cope with underlying problems.  Think of continuous improvement not only as a way to strengthen a healthy company's position, but also as a practice drill or training for dealing with significant challenges that may come some day.

5) Don't Waste Time — Take Action Early.  It bears repeating that in a turnaround, time is of the essence! When financial resources are depleting rapidly and creditors are tightening the screws, solutions must be found before the company accelerates into the ground.  In troubled companies, delay translates into fewer and more Draconian options.  In healthy companies, the same principle applies.

The earlier action is taken to correct a problem, the more flexibility there is to fix it and the less damage that is done; the sooner a process is improved, the more benefit that accrues.  This follows from the lessons above.  At the first sign of trouble, an alert management team has options: it can rethink strategy, make major changes to the business model, get new financing, or implement new information technology.  If the company is running out of cash in a matter of weeks, the alternatives are few and ugly: quick-and-dirty cost-cutting and asset fire sales.

If every CEO, CFO, and senior manager focused on these five basic lessons to improve corporate performance, there most likely would be far fewer insolvent companies.  The difficulty is that most people fear and avoid change—even positive change—because it's uncomfortable.  Yet, it's always better to address weaknesses early, because as problems grow, alternatives diminish.


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