Illustration by M. Scott Ricketts
Is Your Business in Trouble?
If your expenses are higher than your revenues, then your company is not well. Jacques Santucci, Mary Weickert, Dan Walsh, and James Ebbert offer potent medicine, though it may be hard to swallow.
In 2006, a mere 1,250 businesses filed bankruptcy in Maine. Since then, bankruptcies have more than doubled, with an all-time high, so far, of 4,100 in 2010. That’s a lot of Alka-Seltzer.
Some economists say having some businesses close is ultimately good for the marketplace. It’s a way of correcting excesses, thinning the herd, a pecuniary version of Darwin’s survival of the fittest.
Small comfort to the businesses’ owners and employees. In a state like Maine, where small enterprises are the norm, the fall of a business is all of life’s top stressors rolled into one. Financial hardship. Job loss. Moving. Divorce. Breakup of the family. Death of a loved one. People who spend more time together than they do with their own kin, who sometimes have solved problems together for decades, are unceremoniously dispersed. All the things the company provided—products, services, jobs, business for other businesses—go poof.
The four experts in this roundtable don’t like “poof.” They want to help troubled Maine businesses turn the corner.
Dan Walsh, senior VP at Norway Savings Bank, says this requires kiboshing the blame game and taking responsibility for the turnaround. “When a business owner considers himself a victim, and waits for someone else to save him, it’s not going to happen.” Fellow commercial banker Mary Weickert, from Kennebunk Savings, urges owners to be realistic. “A turnaround requires time,” she says, “and it may take several years to establish positive trends on a new, restructured course.”
While bold moves are a must, corporate renewal consultant Jacques Santucci warns that “the most common turnaround mistake is trying to do too much at once.” Turnaround pro James Ebbert, like all the panelists, recommends calling in experts to help. “Let’s face it—most executives have not been groomed to take a company through a turnaround.”
Is your business in trouble? Let’s face it. Plop in an Alka-Seltzer and read on.
What are the signs that indicate a business is in financial trouble? What early warning signs do many business owners/managers ignore?
Dan Walsh: It becomes obvious to the bank that a business is in trouble when we see delinquent loan payments; failure to pay real estate, income, payroll, or sales taxes; or inability to provide financial statements to the bank. By the time these signs are present, it is late in the game, and there are fewer options to save the business.
Earlier signs of trouble are declining sales trends, losses, stretching of accounts payable, or loss of a primary customer. Some small businesses fail to produce, read, and react to monthly financial statements, thus missing the early warning signs. The bank is likely looking at your financials annually or maybe quarterly. A business owner should be reviewing them more often than that.
Jacques Santucci: The lifeblood of a company is positive cash flow. When the operating cash level becomes lower, or the company needs to draw more on the line of credit or push vendor payment over the term limits, the management of the company needs to react and analyze the situation.
A business owner can tend to be overly focused on its sales, its product, its activity, or its employees, and not realistic about key performance indicators of the company such as its gross margin level, the trend of overhead expenses, or its liabilities. We have seen troubled situations created by the lack of focus on the core activity and cash being used for new and unrelated developments or on investments that were not planned properly, creating unnecessary stress on the cash situation.
Another sign is the inability of the top leadership to delegate and share information, particularly in family-owned businesses, masking potential financial issues.
Mary Weickert: At Kennebunk Savings, we’ve seen a number of people who are affected by the economy often in ways that are beyond their control, and so we make every effort to work with our customers to help them weather difficult periods. Some indicators of trouble we see are deposit account overdrafts, delinquent loan payments, and might also include an unusual increase in payables, increased or new debt, and deferred liabilities.
To avoid difficult times, it is best if business owners can adjust and respond to early indicators that things aren’t going as well, such as watching for changes in their cash flow, acknowledging their true expenses, and/or completing an analysis about what lines of business may or may not be most profitable.
James Ebbert: From a workout professional’s perspective, cash is king. Declining cash flow should be investigated for the underlying reasons. Declining revenues would be obvious, but look closely at the business’s gross margin and how it stacks up against the infrastructure costs to support it. Different costs as a percentage of revenues provide insight. Where possible, compare them to other companies in the same business.
While GAAP earnings [earning calculated by applying generally accepted accounting principles] are important and one factor used by lenders in evaluating credit, cash is what drives a business’s success. As an example, think of the heavy string of GAAP losses posted by Ted Turner’s CNN at its inception; its cash flow kept it alive to become what it is today.
In the current economy, do cash flow problems more often come from a lack of income or from too much spending/high costs?
James Ebbert: No one, except politicians, promises year-after-year economic growth. The major problem behind many failures in the past two years has been too slow of a reaction by managements to adjust their cost structures (overhead) to the falling demand caused by the worldwide economic downturn. Once you fall behind the cost curve, you may not be able to catch up. Admittedly, this can mean gut-wrenching decisions related to reductions in compensation, including benefits and layoffs. When making decisions of this nature, never think about how it will impact a particular individual; rather, think about how it will impact the survival of the enterprise.
Mary Weickert: In our view, the impact of our economy cannot be overstated; when revenues, profits, and margins are strong, one is likely to be less focused on cost management.
Because our market is weighted in the hospitality industry, we’ve seen businesses that are hard hit due to the economy’s effect on consumer disposable income, including increased oil and gas prices. With less disposable income, reservations and volumes have decreased, and those that do travel are often shortening their stays and spending less on food and extras. Furthermore, increased heating costs have been challenging to absorb. I have seen numerous business owners make the difficult decision to close for the winter months in a drastic effort to reduce overhead.
Jacques Santucci: Overall, cash flow problems do not originate only from lower sales or changes in the cost structure.
Often they begin when the company and its management fail to adapt to changes in their business environment that result in lower sales or changes in the cost structure. The global economy is constantly changing and tough economic times will always be a part of the business cycle. Some companies resist these pressures more than others, particularly the ones that have a clear business model, use solid forecasting and reporting mechanisms, and do not hesitate to identify and address all potential problems.
Dan Walsh: In the current economy, it is more likely that we will see a business struggling with a lack of income because of the lack of demand and the prolonged weakness in our economy, rather than a high cost structure. Each business’s cost structure is so unique that it is hard to say there is any one place that costs are most often too high. The business owner/manager needs to take a hard look at every expense, line-by-line, to find a way to fit expenses to the company’s revenues.
What role do inadequate financial reporting systems have in failing businesses? What does a good financial reporting system look like?
Dan Walsh: A business should be generating an accurate income statement, balance sheet, and accounts receivable and accounts payable agings monthly, and the owner/manager should understand how to read those reports. When we see a small business fail, there is too often a manager/owner who did not generate, read, or understand their financial reports, or there was a bookkeeper who was not accurately inputting the information.
For example, several times we have seen a bookkeeper book loan proceeds or capital contributions as income on the income statement, rather than booking them on the balance sheet. This obviously overstates income, and a savvy owner/manager should recognize this type of error and other similar errors upon review of the reports.
Jacques Santucci: It is difficult to make a generality regarding the role of an inadequate financial reporting system in a failing business. The question is first: Are the business managers reading the financial reports regularly? Are the indicators chosen by the management appropriate? In the case of the financial statement; is the chart of accounts correctly set up, representing an accurate view of the business? Is the record keeping done accurately, classifying the information in the appropriate buckets?
We have seen a wholesale company that issued a daily gross margin report of over 150 pages in small print and in no particular order. None of the five managers of the company were looking at it. Who has the time to review thousands of lines in search of an anomaly? It took them five weeks to find an error in purchasing which led to a significant negative gross margin and cost the company thousands of dollars.
Following the error, the thick gross margin report was replaced by a one-page report showing only the major issues.
Mary Weickert: Inadequate financial reporting makes it difficult for an owner or manager to identify and respond to challenges that can ultimately cause a business to fail. A business cannot evaluate their business plan and projections without monitoring the makeup of their revenue stream and expenses on a regular basis. Quickly identifying and responding to an issue such as an increase in labor costs can make a difference to the bottom line within the quarter, as opposed to looking back at year-end.
Today, small businesses have many affordable options to utilize accounting software that provide comprehensive tracking and reporting. A good system provides the user with the ability to generate a variety of reports beyond the standard profit and loss statement and balance sheet. Receivables, payables, and any specific category report can be generated for any given period. It also enables the user to compare data for the same period year over year.
James Ebbert: Having been in the workout profession for 20 years, it boggles my mind how many companies do not know the true costs of their manufactured products or services. This can be the result of poor financial reporting, or simply ignoring what the reports are saying.
Examples of inadequate information are endless, ranging from failure to account for production downtime for machine changeovers to simply not including obvious expenses such as shipping. I have seen managements “fudge” costs in order to justify doing business with high profile customers, such as the big box stores. A construction company client ran 20% over on a fixed-priced contract and did not realize it until a month after the project was finished.
Finally, often there are too many reports with too much detail that intimidate (encourage) one to ignore them. A CEO should receive a daily one-page report showing the business’s key production and financial parameters.
What are banks looking for from their troubled business customers? What makes them nervous?
James Ebbert: Lack of communication and last minute surprises. The last thing any lender wants is a phone call out of the blue at 4 p.m. on a Thursday afternoon saying, “Joe, we have a problem. Tomorrow is payroll and we don’t have enough to cover it. We need another $100,000.” Believe it or not, this happens when many borrowers begin to fail. This last minute, frantic call prompts the following thought process from the lender, who may or may not communicate it, depending on his or her mood. “First, did the company just discover this? Second, why didn’t you call me weeks ago to indicate you were experiencing some difficulties? Had you done that and come to me with a plan on how to get over the crunch, I could have worked with you. Now you have put me in the impossible position of deciding whether or not to close down your company by asking me to fund your payroll.”
Mary Weickert: It’s true that we, as banks, like to have our loans paid back! Luckily, as a mutual, community bank, we’re able to look at our borrowers who are having trouble with compassion and patience. There’s an art to working with businesses that are having a hard time and developing a mutually agreeable plan.
A successful workout action plan must accurately identify and address the problems. Borrowers are most successful when they show a willingness to accept change with patience and a positive attitude. It can be very difficult for owners to make the hard choices of prioritizing payments. Ultimately, though, we both have the same goal: having their business be productive and profitable and paying their bills.
Banks get very nervous when customers don’t want to work with them, or are unwilling to face the realities and reasons behind their troubles.
Dan Walsh: First and foremost, we would like the customer to communicate clearly with the bank. Ideally, a borrower can formulate a plan to address the problem, and that plan can be discussed with the bank. What makes me nervous is a customer who does not return phone calls, does not acknowledge there is a problem, or doesn’t fully disclose information to me.
Jacques Santucci: A lender or an investor does not want to run the business on a day-to-day basis. A bank usually lends to a company based on the ability of the company to keep the value of its collateral and to execute its business plan while generating cash. Although I am not a banker, my experience is that a financing institution is expecting a troubled customer to be proactive and realistic about the situation while keeping the bank informed.
Once it’s clear that the company has cash flow issues, a plan to address the situation must be put in place and all stakeholders, including the bank, must participate. Cash flow management is critical and banks typically require a cash flow forecast with regular updates and realistic assumptions. The lack of vision of the management, unrealistic expectations, and inability to illustrate past performances or financial forecasts would likely create stress in the banking relationship.
What are some creative ways you’ve seen businesses get themselves out of trouble?
Jacques Santucci: Every situation is different and you need to combine traditional management methods, creativity, and a realistic approach to the problem to develop a feasible plan to get a business out of financial trouble. The most common approaches include adapting your business model, selling assets, or looking at your cost structure. You sometimes hear of companies in financial trouble laying off employees, usually higher paid ones to reduce expenses. Employees are typically the best assets of the company.
An interesting approach that we have seen while a company was trying to get out of trouble was to keep the top management and incentivize them on “laying off” their least profitable customers—the ones with lower margins and the ones that require too much time and break employee morale. That approach combined with a strong grip on cash management and open communication with their partners, particularly major vendors, brought the company back on track in a few months.
Dan Walsh: The most successful strategy we’ve seen has generally been shrinking the expenses to right-size the company to the new revenue stream. We have also seen businesses sell unproductive assets (such as land held for development or an unproductive location) in order to generate additional cash or retire some debt. Another alternative is for the business owner to sell personal assets in order to generate cash to contribute to the business.
James Ebbert: One of the first places to look for cash is stale inventory—raw materials and finished goods. It is not uncommon to hear, “We can’t sell it for that because it won’t cover our costs.” Those costs are sunk costs, and holding the inventory represents an opportunity cost. The same applies to equipment that is no longer needed. Excess space (either owned or leased) can sometimes be sold or subleased.
Collection of accounts receivable is another source. Believe it or not, when first being engaged, I often find large amounts of uncollected receivables—even from credit-worthy customers. The client has no collection program and no individual
effectively working the accounts.
Stretching out accounts payable is another possibility, assuming they are not already stretched to the point where suppliers are refusing to ship.
What are some of the preventable problems you’ve seen that might not have happened if the business had sought professional advice earlier?
Mary Weickert: There’s no substitute for professional guidance and putting that guidance to good use. It’s important to have a solid legal and accounting framework on which to build any new business venture. Many seek appropriate professional advice at the start-up of their business, but use it only as a onetime service.
I have seen a number of borrowers successfully grow their business, yet the legal structure and accounting practices remained unchanged. In one instance, multiple real estate investments were made and supported by business cash flow; however, individual accounting was not set up for each property. As the economy slowed, the borrower began to experience cash flow problems, and they were unable to identify the real underlying problems and react quickly. Many of the problems the owners experienced could have been minimized had they sought professional guidance to help manage growth and change.
Dan Walsh: Your accountant should be more than just the person who prepares a tax return for you once a year. If you don’t know how to read your monthly financials, ask for a lesson. If you don’t understand your financial reports, it’s unlikely you can solve the financial problem.
You should also feel comfortable using your banker as a sounding board. There should be more to your banking relationship than just “renting money” from the bank. Your banker may be able to give you some perspective on the issues you are facing.
The business owner in financial difficulty may also get value from hiring a seasoned reputable turnaround professional to assist with a plan. It is more likely your turnaround plan will be realistic if you hire the right professional. An attorney is also an important part of the professional team. If your regular business attorney does not have a background in working with troubled businesses, he/she may be able to refer you to someone who does.
It is difficult to justify more professional expense when cash flow is tight, but having a good team of professionals behind you may mean the difference between a successful turnaround and liquidation.
James Ebbert: The most serious problem a workout professional encounters is denial on the part of the CEO or owner that there really is a problem. Time and time again I hear: “It’s the bank’s fault”; “The bank doesn’t understand”; “It’s the economy’s fault”; or “We’ll get a big order next week which will solve our cash problem.” This type of attitude is most certain to kill any hope of a successful turnaround.
Employees’ attitudes mimic those of their leaders, and if their leaders are blaming everyone else, so will they. Turnaround plans often involve operational changes and employee sacrifices. When implementing a turnaround plan, I always tell employees that in a turnaround, I often value attitude more than experience. If they cannot accept the changes and get on board, it is better to leave now.
Often CEOs begin to bend to the pressure, making promises of all kinds they cannot keep. This, unfortunately, puts employees down the line into uncomfortable positions. A good example are accounts payable personnel who will often tell an angry vendor that the check is in the mail or that it will be sent next week, even if they know that not to be true.
Retaining professionals early in the process prevents these mistakes and brings credibility to the situation. And, yes, they are not cheap and they will want retainers.
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