More often than not, managers can’t see the situation of a business worsening. This is bad. Why? If they don’t know that a crisis is happening, it’s difficult to turnaround a situation.
A business strategist is specially equipped with skills to recognize such situations, management and leadership can figure out when a business is doing poorly. Despite the situation, many fail to take suitable corrective action. Oft-times a manager would underestimate the situation of the business because they were looking at the wrong data. Some take advantage of easy access to capital and think they will push through the situation regardless of poor performance. Others become focused on short-term growth that they neglect long term health of the company.
The executives who keep a clear head in such situations and step back to review the plans, measure their operational performance against expected performance get a clear view. Understanding what’s not working is the first step in recognizing that a company is heading towards distress.
Here are four more tips for companies to recognize when a company is in distress.
1.Do not have one definition of a company in distress.
It is nearly impossible to define a distress situation for a company. At times, distress can be caused by multiple problems working together. There are 25 different situations of potential distress for a company. The distress is often a result of multiple problems occurring together.
The following are some factors that can show early signs of a fallout.
- Working Capital
- The decline in free cash flow
- High contingent liabilities
- Unresolved debt maturities
- Increase in outstanding accounts payable
- Shrinking EBITDA
- Reduced capital investments
- Deteoriating regulatory environment
- Diminishing market
- Decline in stock price
- Decreasing liquidity
- Decline in bond price
- Losing ability to file financial statements
- High employee turnover
- Insubordination of managers
- Management turnover
2.Scrutinize your plan
Reviewing your business plans periodically is a good idea. Doug Yakola, McKinsey executives, suggests that it’s better to build triggers in the plan. Upon a periodic review of the plan, managers can see if the desired state has been reached or not. In case of failure of reaching the desired milestone, managers can step back to review the performance of the organization and take corrective action. A business strategist or strategy manager typically ensures that reviews happen regularly or the management can take up the job.
Triggers should be added whenever the plan is made – at the beginning of the year or at the start of the three-year cycle. Further, keep trigger points in a way that checks operation and market performance, financial health, and cash flow.
In addition to that review your performance with respect to the industry and your competitors. At the same time, check if you’re moving with the industry. If you’re not, then your plan might be obsolete. Don’t forget to look back at your performance over the last cycles. Inconsistent performance records and dampening performance can indicate distress down the road, which would require investigation.
3.Bring the board on board
The role of the board is usually undermined by managers who see the board as a necessary evil to run their business. Contrarily, the board sees a business as a forest rather than a tree. This allows the board to spot early signs of distress easily.
Furthermore, the board should be the one to be confident and ask CXOs that how the company can cut costs. The responsibility to spot challenges and risks and safeguard the company against risks falls upon the board. A distress usually results due to the consistent poor performance of 18 to 24 months. To mitigate such situations, the board has an important responsibility to play.
The senior team or strategic leadership team keeps a list of risks to the business, employees, and the plan. Revisiting those risks on a quarterly basis with the board on a quarterly basis keeps the risks on top of mind and on track to avoid them. It is a good way to have conversations that you wouldn’t typically have in a business operation.
4.Focus on cash
A strong focus on cash makes the turnaround faster. This means bringing business back to its basic elements. Is the business generating cash or burning it? When a business is stripped to basic elements of success, the steps required to take become clear. The management team and the board often focus on complex metrics like EBIT (Earnings before interest and taxes) and return on investment and exclude major uses of cash. EBIT excludes major cash expenditures like rent or fuel.
These are fine metrics but do not provide real insight as focusing on cash does. However, keeping a check on bank balance isn’t always required. Companies need to keep a good forecast to maintain a longer view. A routine check on capital investments is essential as well. Net project values can look the same whether the returns begin in the first year or shoot up significantly at five years. In the end, if you’re not focusing on the cash while waiting for investment, you may find yourself no cash to run the business.