Editor's Note: This article is intended for newer entrants into the industry. Look for more content like this throughout the year.

Most organizations move along a continuum. Diametrical opposites, the end points of the continuum reflect a very different state of affairs. At one end of the continuum is the custodial environment, which is relatively stable and resource rich. The organization is profitable with growing revenues as reflected in both margins and market share. This provides access to additional capital if required. Information provided to management is timely, relevant and reliable. It is used by a competent and stable management team. In this environment there are no threats from creditors. And there are no other threats that represent a clear and present danger.

At the other end of the continuum is distress or crisis, which is a harsh, unforgiving, ambiguous and urgent environment. Losses are likely, with numerous threats from a variety of stakeholders. Some, or all, important financial indicators, such as sales, margins and market share are in decline. As a result, cash is likely in short supply and liquidity may be a serious issue.

Management information systems (MIS) and accounting may be adversely affected by the extraordinary demands for resources. The ability to deliver useful information is further impaired by human nature. Denial and a paucity of critical thinking are often linked. This is further compounded by a reluctance to be the harbinger of bad news. The most common characteristic of the distressed organization:  financial data will almost always be erroneous, missing, inaccurate, incomplete or even fraudulent.

In this setting often the question of valuation from a liquidation or turnaround becomes salient. However, this is but one part of the more fundamental choice that stakeholders face and that is to choose to attempt a turnaround or dispose of the company in some fashion. The real question becomes: “Can the company reverse its fortunes or not?’

The news is full of stories about companies with huge valuations even while they accrue massive losses. It is staggering to see how they often have no path to recovery.  They merely seek more growth fueled by stakeholders. How such growth will yield profits is scarcely even understood.  At least some of these organizations will face bankruptcy in the near future.

Any analysis of viability must address the parameters required for turnaround success, including a viable core product, competent management and sufficient financial resources to implement a turnaround. Under the circumstances, conducting the process can be daunting to say the least. It may be useful to consider the following:

1. The Goal is to answer fundamental questions: Is the company viable and can it reverse its fortunes?

1.  The Parameters that we use to answer the question are: Does the organization possess competent management, a viable core product and sufficient financial resources?

1. The Tools that are used to assess viability also provide the platform to implement a chosen strategy, either a turnaround or disposition. These are: the cash budget, balance sheet and income statement.

In addition to answering the fundamental turnaround/liquidate question, this analysis will yield many benefits:

• It will reveal flaws in the MIS/Accounting synthesis and provide a path correcting any deficiencies.
• It will yield a whole host of information that is relevant, reliable and timely.
• In addition to answering the fundamental turnaround/liquidate decision this exercise will provide a wealth of knowledge necessary to implement a turnaround or to maximize recovery through disposition.
• The process will re-establish corporate discipline and provide a platform for sustainable recovery.
• It will provide a comprehensive process for cash management that will control disbursement, husband resources and locate new sources of capital.
• It will assist in managing the numerous threats that face the impaired organization.
• It will quickly reveal information concerning the quality and ability of management.

The Process

The process of analysis begins with the assumption that current data is flawed, erroneous, or insufficient. The steps required are:

1. Cash Management. Tactically this process ensures short-term survival and enables data gathering.

2.  Establishing an income statement that is accurate, timely, relevant and reliable

3. Ensuring that the current balance sheet reflects accurately all outstanding liabilities and a realistic view of asset value. Such value should be orderly liquidation under current market conditions. This is likely lending value.

4. Creating financial projections, integrating income statement, cash needs and balance sheet.  

This exercise will determine if the three parameters of turnaround success can be met. If so, the analysis will also provide the platform for a strategic plan of recovery. If the parameters are not met then the information obtained will permit maximum recovery under liquidation or disposition.

Cash Management

Cash management is the first step of any analysis. It pays for needed goods and services and ensures that the organization can continue to operate. It is also used to manage risks that appear rapidly and in multivariate form. Cash is necessary to execute and implement a plan for a reversal of fortunes. Cash management requires control, conservation and the search for additional resources.

Control begins with the centralization of the authority to disburse funds. This may be more than one person,  but will be as few people as possible. Control and conservation are further enhanced through the use of two reports: the daily cash report and the weekly report. The daily report includes not only cash availability, but loan availability and outstanding checks. The weekly report extends up to 13 weeks in a “rolling fashion.”  Above all, these reports must be accurate and truly encompass both revenue and required disbursements. In aggregate the cash management process:

• Provides an early warning system in terms of liquidity
• Begins to provide information concerning operational performance
• Clearly identifies resources, disbursements and their priority
• Assists in risk management by indentifying all obligations – including legal matters
• Is used or integrated with other information such as sales reports or disbursement records, to track performance and enhance control.

Whatever the challenges, additional cash is essential for recovery and the search must begin immediately. All alternatives must be explored and it is unlikely that any single source will be sufficient. Success is often determined at the margin.

The Balance Sheet

The process of seeking new sources of cash includes both information relevant to operational performance and the balance sheet. It is necessary to create a balance sheet that is based upon reality, accurately reflecting outstanding liabilities and asset value. In the distressed organization, asset value will be determined as it would be through the eyes of a pawnbroker, reflecting current market conditions and the exigencies of distress. In general, the process should be met with a healthy dose of skepticism, taking nothing for granted. The following steps are useful.

• Visual inspection and inventory of all tangible assets at all locations, including plants, equipment, vehicles, real estate, and inventory.
• Inventory of all intangible assets, including A/R, patents, trademarks, leases, and interests in other entities.
• Professional valuation of assets under two scenarios: liquidation under distress and liquidation as a going concern.
• Confirmation from source for current balances of all loans ,mortgages, and financial liabilities, with particular attention paid to those that are less obvious such as third-party liabilities and contingent liabilities
• Verification by competent legal counsel of all encumbrances, liens or mortgages on company assets.

This process reveals opportunities to raise capital through refinancing, divestiture or any other change in the Assets or Liabilities such as increasing the collection time on A/R, or terms on A/P. 

The process also begins to address the important issue of the funds that will be required to execute a turnaround and just how they will be found.

The Income Statement

Ultimately, profitable sales will drive recovery; unfortunately, distressed organizations often sell at low margins or even below costs. Management often takes the view that getting business is the most important goal, ignoring margin.

An analysis of the income statement will gather data that is relevant, reliable and accurate for both revenue and expense. Where MIS/accounting has become dysfunctional this becomes a recursive process. As data is gathered it is checked for veracity. Should it be flawed it is refined and improvements to the MIS/ accounting function are begun. Although this poses a difficult situation for the turnaround manager, it is possible to obtain quality financial information with some dispatch. At a minimum, an accurate picture of the following should be provided:

• Sales by product, product line and region.
• Gross margins by product line and preferably by product
• Total expenses by category and preferably with proper allocation of expenses to functional areas.

A Fundamental Decision Revealed

At this juncture, much has been revealed about the organization and its ability to execute a turnaround. Both assets and liabilities have been recorded at a realistic value, providing opportunities for raising additional capital through divestiture or the mitigation of liabilities. It may also pave the way for refinancing or DIP financing. Ultimately the exercise will reveal if sufficient capital can be found to complete a turnaround.

A fresh look at the income statement will highlight income and from where it is derived, by product, product line and region. The accurate aggregation of costs and allocation to appropriate areas will allow a true understanding of both contribution margin and just how costs are allocated. In total, this information will clearly indicate if the company has product(s) that show viability through sales and contribution margin.

This entire exercise will provide a show case of management talent and management deficiencies, allowing any necessary changes to be made for turnaround execution.  

Lastly, turning information into projections that integrate financial performance and cash needs will answer the fundamental question: Is the organization able to reverse its fortunes or not?

About the author:

Tom is a specialist in interim and crisis management with 20 years of senior management experience in financial, operational and statutory restructuring. He has served as Chief Restructuring Officer, Chief Executive Officer, and Chief Financial Officer in a wide range of business sectors including health care, structural steel, garment manufacturing, yacht building, die cast, railroad repair and food processing. He is recognized for his achievements in the following areas: statutory restructuring;cash flow management, creditor negotiations,management assessment,performance management,corporate strategy or business planning,organizational assessment,and corporate due diligence.Tom has successfully restructured organizations through informal arrangements with creditors and by statute. He is one of the few turnaround professionals experienced with the insolvency regimes of both Canada and the United States. Prior to his work in corporate renewal,he was engaged in corporate lending with a major Canadian Bank winning several awards for innovative solutions tailored to client’s needs.

Tom successfully completed the stringent accreditation process of the Association of Turnaround Professionals and was awarded the Certified Turnaround Professional designation in 2001. He also holds a Bachelor of Business Administration with Honors from Brock University in Canada.Articles authored by him have been published in such venues as: the Journal of Corporate Renewal,the Secured Lender, The Commercial Lending Review and the Provider.

Tom has been the president of his own consulting firm TCMI Limited since 1995.TCMI is a provider of management consulting,turnaround or crisis management, corporate restructuring, and renewal services to companies in financial and operational difficulty.

The goal and purpose of TCMI is to increase the value of our client’s business through corporate renewal. We serve clients in both the United States and Canada providing strategic,consulting,interim management, and creative restructuring solutions for companies facing managerial,operational,and financial problems.We restore and create value through a highly effective restructuring process.  

In the role of either consultant or interim management ,TCMI does not just provide the client with reams of complex spreadsheets but rather takes an integrated approach to truly enhance value.

Tom can be contacted at:

Phone: (905) 687-2119
Email: tonich@turnaroundinternational.com