How Turnaround Helps

A company with excessive debt, stringent covenants, and inadequate equity capital is operating with little or no margin for error. Credit is overextended, inventories are accumulating, and fixed assets are underutilised. The introduction of better working capital policies and improved capacity utilisation decisions are clearly warranted in suchcases. Yet, incumbent management instead often engages in debilitating  attempts to grow the company out of its problems.

A weakened financial condition has led to the company developing an adversarial and unproductive relationship with its lending institution(s). Fearing that its loan relationships and facilities may be in jeopardy, the company tries to conceal financial information from  its lenders. Telephone calls from the bank are not returned. Interim or  periodic reports are not filed. Since money is the lifeblood of most any business, this kind of lender relationship only leads to more trouble and compounds the difficulty of managing the declining business operations.

The company is operating without adequate reporting, accountability, and responsibility mechanisms. This is tantamount to flying an airplane without an instrument control panel. Management decisions based on inadequate, untimely, or inaccurate information can make a bad situation considerably worse.

Changes in the product and customer marketplace have bypassed the company, leaving it with sagging sales and declining market share. For some businesses, the source of the deficiency is technology; their equipment or products and services have become obsolete. For others, the problem lies in sales and marketing; the company hasn’t kept pace with the needs of the marketplace or the ability to distribute its products effectively to the customer base.

The business is growing rapidly. A business that is a success at $5 million in sales a year can become a dismal failure at $10 million. Companies achieving fast growth from concentrating on boosting sales often overlook the effects of that growth on the balance sheet and the cash requirements of funding it. Growth often carries a very high capital investment requirements, including significant investments in R&D, capacity, and working capital. Leveraging a company to meet these increased funding needs typically means that management must operate with little or no margin for error.

In addition, growth has led to overwhelming the capabilities and effectiveness of management and employees alike. Staff is not able to work successfully at the new level. For example, management of engineering operations for a company with 12 plants is much different than managing a similar business with perhaps one or two plants. The same challenge applies to others in key positions in marketing, sales, operations, and manufacturing. A company can grow beyond its ability to manage.

Changes in the product and customer marketplace have bypassed the company, leaving it with sagging sales and declining market share. For some businesses, the source of the deficiency is technology; their equipment or products and services have become obsolete. For others, the problem lies in sales and marketing; the company hasn’t kept pace with the needs of the marketplace or the ability to distribute its products effectively to the customer base.

Change can begin only when company leaders have decided that changes are necessary. As most CEOs or company presidents do not relinquish power easily, the motivation for management change must often come from the Board of Directors. Even if incumbent mangers are willing to implement changes in an effort to turn a company around, they often lack the credibility or objectivity to do so because they are viewed as having caused or contributed to the problems in the first place.

During this stage or after Stage Two – situation analysis – steps are taken to weed out or replace any top managers who might impede the turnaround effort. This may include the CEO, CFO, or weak board members.

In the final step of a turnaround, a company slowly returns to profitability. While earlier steps concentrated on correcting problems, the final stage focuses on institutionalizing an emphasis on profitability and return on equity, and enhancing economic value-added. For example, the company may initiate new marketing programs to broaden the business and customer base and increase market penetration. It may increase revenue by carefully adding new products and improving customer service. Strategic alliances with other world-class organizations may be explored. Financially, the emphasis shifts from cash flow concerns to maintaining a strong balance sheet, securing long-term financing, and implementing strategic accounting and control systems.

This final step cannot be successful without a psychological shift as well. Rebuilding momentum and morale is almost as important as rebuilding return on investment. It means a rebirth of the corporate culture and transforming negative attitudes to positive, confident ones as the company maps out its future.

Of course, not all turnarounds succeed in the manner outlined here. A company may put a quick end to its disastrous losses but never quite attain an acceptable return on investment position. When this occurs, management may decide to sell the business to a company and management team better able to produce an acceptable return on the funds invested. In a sense, however, this outcome is not failure at all. The company may well thrive and reach new heights under different ownership. Here, the turnaround manager can play a key role in identifying prospective purchasers, managing the information disclosure process, and negotiating a successful sale of the business at a price that maximizes the capital available for distribution to existing financial claimants.

Ironically, some companies never reach Stage Five because they achieve significant success in the earlier steps. The turnaround becomes so successful that the company becomes a target of a takeover bid. Again, this must not be viewed as a failure. The company was saved and continues to perform well with stronger sales than ever before.