What is a business turnaround?

A business turnaround is everyday management to rescue a declining company that has been performing badly for a long time and will fail without corrective action. A turnaround aims to stabilise the business and secure its future.

Turnarounds occur at the pre-insolvency stage and require a business to carry out informal actions.

Business turnarounds are hands on and require:

● Acknowledging problems in the business.
● Considering the changes needed to solve those problems.
● Developing and implementing a problem-solving strategy.

How do you turn around a business that is failing?

A business turnaround plan is the blueprint to saving a failing company. The plan needs seven key ingredients for the turnaround plan to work well:

1 Crisis stabilisation
2 Leadership
3 Stakeholder support
4 Strategic focus
5 Organisational change
6 Critical process improvement
7 Financial restructuring

There are various strategies needed to make each of these ingredients work. For example, under crisis stabilisation, there are strategies such as taking control of the business, cash management, asset reduction, short-term financing and first-step cost reduction.

What are the key characteristics of a successful business turnaround plan?

For a business turnaround plan to be successful, it must have these characteristics:

● Address the fundamental problems in the business.
● Tackle the underlying causes of the problems, not the symptoms.
● Be broad enough in scope to acknowledge and resolve all the key issues.

An effective turnaround plan considers the big picture and not the individual problems in isolation. Make sure the plan does not get bogged down in too much detail. It’s much better to act fast rather than spend days working on an overly detailed plan.
That said, the plan won’t work if it’s not carried out efficiently. When executing your turnaround plan, make sure it is:

●Comprehensive: It needs to be both tactical and strategic.
●Non-linear: The timing of a successful turnaround process requires simultaneous rather than linear sequencing.
●Wide-ranging: Broad enough in scope to tackle soft and hard issues, and short- and long-term priorities.

How do you implement a business turnaround strategy?

At Byronvale Advisors, we break down the business turnaround process into four overlapping phases:

Analysis phase
At this stage, perform a diagnostic review and then evaluate the turnaround options. Choose one option and get started on the immediate crisis actions. Establish a trusted turnaround team so they can develop a plan.

Emergency phase
This phase involves executing and managing the actions required within the plan. There is usually a heavy focus on liquidity management, operational factors, cost control and stabilising sales.

Strategic change phase
This phase looks at areas that will strengthen the business in the long-term – revisiting standard operating procedures, looking at IT systems and processes, or considering products and markets to decide what changes the business needs for ongoing and long-term viability.

Growth and renewal phase
Once the business balance sheet has improved, the business can either grow again organically, via merger or acquisition, or both.

Each phase incorporates several of the ‘ingredients’ and turnaround strategies mentioned earlier.

How sophisticated and intrusive the turnaround implementation will be depends on the complexity of the issues, the size of the business, and how much help the directors want from the turnaround consultant. An engagement might last a few months or 2-3 years.

What should be the first step in the turnaround management process?

The first step in a business turnaround management process is a thorough business analysis. Do a diagnostic review of the entire business to assess the issues and then prioritise what to do to fix them. This diagnostic review is best done by an experienced turnaround consultant.

After this, company management and the turnaround consultant will agree on a strategy to address and remedy the issues.

Do you need one of our turnaround consultants to look at your business and advise you on a business turnaround? Call 1300 004 404 or email info@byronvaleadvisors.com.

In Australia, company restructuring engagements are a relatively fresh approach to preserving and improving business operations, particularly for small to medium businesses.

Restructuring a company involves reorganising one or more aspects of the business to increase its efficiency and profitability. Restructuring is an umbrella term that encompasses four distinct groups of activities:

● Expansion
● Contraction
● Financial Restructuring
● Organisational Restructuring

A company restructure aims to rescue a business and avoid liquidation or insolvency outcomes . If this is not possible, a restructuring may also provide better outcomes for the company, its creditors and directors.

How you restructure your company will be unique to you and your situation. However, there are four major benefits that come from the process of business restructuring.

Reduce Costs

A company may lower its operational costs if it downsizes during restructuring. For example, the business can cut its payroll expenses if it dismisses some of its employees. Outsourced operations are usually less expensive than in-house labour. Thus, the cost of maintaining operations within the retail network and company specifically decreases with restructuring. Costs would also reduce if the company could merge with another company that is very similar and use economies of scale to run more efficiently.

In this way, the company can expand its reach without adding too much to the overhead of the business. If handled correctly, the business will provide significant value for its shareholders.

Better Communication

Decision-making and communication will usually improve when a company removes or reduces layers of management during its restructuring.

By streamlining its management structure, the company reorders its organisational hierarchy, which opens the lines of communication and removes any burdens impeding productivity.

More Efficient Operations

A company’s overall operations may become more efficient if it brings in new technology during its restructuring process. For example, digital workflow management programs will help employees keep track of what tasks they need to do and how they align with those of their colleagues. Accounting software can help finance departments record all cash flows and ensure that the business leaves no transactions out.

This way, staff and management won’t get bogged down in menial work and can instead focus on tasks that help grow the business.

Increase Value of Business Units

A primary reason a company will restructure is to divide the business up for sale. If a company is trying to sell as a conglomerate, it will probably get lower offers from investors.

However, when management divides the company into separate business units, it can often get more attractive offers for those individual components. This can raise the value of the company and may secure a more lucrative sales price for the business.

When done properly, a business restructure makes your business more dynamic and innovative . It becomes more efficient, robust and profitable. However, improving and streamlining your business operations to achieve your business goals is no simple task. You may not know what to do or even where to begin.

An experienced restructuring advisor will look over your business and its circumstances with a fresh pair of eyes, and provide you with the advice and expertise you need to get on track to running your business better.

Do you need one of our restructuring advisors to help you restructure your company? Call 1300 004 404 or email info@byronvaleadvisors.com.

In Part 1, I outlined the 10 financial figures and ratios, how to compute them and what they show. However, to make the most of this information you must understand what the information is telling you and how to apply this information in your business. The 10 figures and ratios were grouped into three types – Profitability, Activity and Liquidity.

Profitability

If we find that the profitability numbers are low, we can take some quick steps to improve the numbers.

Increase revenue

“How do we do this?” I hear. “We are selling as much as we can and we can’t afford the investment in more staff or materials, and even if we could we don’t have the capacity!” Or, “It is a competitive marketplace and we have to sell our product as cheaply as we can.”

How about increasing your revenue by 2% every year? Cost pressures rise with inflation – the raw materials, fuel etc. all rise by a small amount gradually. When they do, your profitability – gross margin – is getting squeezed.

Let’s say you buy a coffee every morning on your way to work for $3.60. It’s convenient, and the coffee is good. One day, you go to pay for your coffee and the price has increased to $3.70 – you would most likely pay the $3.70 and continue your normal daily routine and continue paying $3.70. This is a price increase of 2.78%.

These slight increases either protect your Gross Profit Margin or goes directly to your overall profitability. Furthermore, how many customers would you be likely to lose? Customers that are so sensitive to such small increases are often customers that you are better off not retaining. To minimise the impact try even smaller but more regular increases, perhaps quarterly – the impact on the customer is even less noticeable.

Another way to look at this is –

2% increase = it is unlikely you would lose a customer

10% increase = would you lose less than 10% of your sales in dollars?

50% increase = would you lose less than 50% of your sales in dollars?

Reduce Cost of Goods Sold

This is a lot harder than increasing profit as you are restrained by the variable components making up the cost of goods sold, and the volume being produced and/or sold. Apart from improving profitability, I think the process of looking at how you can reduce the cost of goods sold will give you a much better understanding of the drivers, pain points, restrictions, and opportunities in your business.

But here is a list of ideas – not all, and maybe only a few will be applicable to your business.

● Source cheaper inputs or materials. I worked with a steel manufacturing company and the supplier of a raw material would sometimes restrict supply to keep the average price higher. Not only did this affect certainty of supply, but it also kept the cost of goods sold high. This company turned around and sourced an alternative raw material from overseas, which in turn led to a joint-venture proposal.
● Just in time – buy the materials when you need it. The same steel company had an inventory policy whereby if they sold a particular item they would reorder the material immediately. While I was with the company, they sold steel for a wine vat and reordered the materials – that hadn’t sold steel for a wine vat for the four years prior and they probably haven’t since.
● Buy in bulk – yes, I just said buy just in time, but if you have the capability and the working capital, you may find buying in bulk will lower your per unit input cost and the cost of goods sold.
● Reduce waste – particularly if the cost of the raw material is high. Let’s say you make granite benchtops – a high-cost material. If you can use exactly the right size material, you will minimise the waste and reduce your cost of goods sold.
● Standardise product features – remember what Henry Ford said about the Model T Ford – you can have it in any colour as long as it’s black. Reducing options and non-standard features will reduce your costs.
● Look at total cost – the material cost is just one factor – what about funding costs, delivery costs or delivery time. Could you pay for the material quicker and get a more favourable price? Could you order earlier and reduce postage costs with slower delivery?
● Team up with someone else – could you team up with someone else to get a better price?
● Get a long-term supply contract – At Byronvale Advisors, we discount our hourly rate to clients that enter fixed price or retainer contracts. Apart from providing certainty of cashflows for us, it lowers the price for the client, and it provides them price with certainty.

Activity ratios

Activity ratios tell the business how efficiently they are using their short-term assets, especially cash.

Having lots of capital tied up in inventory and debtors means the business has to get the cash to pay for them – either through its own reserves, borrowings or by delaying paying creditors.

What is optimal depends on the industry and the products being sold, but as a generalisation: –

Debtor days < Creditor Days – have your customers paying you before you have to pay your suppliers
In the example above Debtor Days were 38 days and Creditor Days were 60 days – customers are paying quicker than the need to pay the suppliers.

Inventory Days < Creditor Days – you are selling the inventory before you have to pay for it
In the example above Inventory Days were 61 days and Creditor Days were 60 days – inventory is being sold about as quickly as the suppliers are being paid for it.

With inventory there are a few common factors to be mindful of: –

● Accounting valuation method can affect the overall valuation of the inventory.
● Obsolescent or hardcore inventory can affect the inventory valuation and days. Accounting standards do also have rules for writing the valuation of obsolete inventory down.
● Buying inventory at a discount can both positively and negatively impact Inventory days. There is a balance between the value of the discount and the cost to fund the increase in inventory.

Discounting sales can affect working capital positively and negatively. Offering customers a discount may increase the sales and/or decrease debtor days. If the discount increases the sales but does not decrease debtor days, then consider the impact of working capital and cost of funds. Likewise, if the discount reduces debtor days but does not increase volume, what is the impact on gross margin and profitability?

Chasing debtors is never fun, but remember, the debtor amount is your money that someone else has. Would you be comfortable lending the customer the same value in cash that you withdrew from your bank account? It makes a big difference to your bank balance if they pay you.

I have only ever had one client that turned into a bad debt. It was when I had sent several reminders and finally threatened legal action that they put themselves into voluntary liquidation. During this period my wife had been saying I should have been pursuing the client and threatening legal action but my rhetoric question to her was “If the client walked into our house, found my wife’s purse and took all the cash out of it, put it in their pocket and walked out the door what would you do? You need to invest the time to ensure you are paid in a timely manner and pursue late payers.

Liquidity ratios

A caveat on Liquidity Ratios – the ratio is just the start of the conversation. Ratios need to be benchmarked against like businesses and over a period of time. After the ratio is determined analysis also needs to be undertaken of the makeup and timing of the liabilities.

A not-for-profit client had a balance sheet similar to this:

Current Assets
Cash 20,000
Prepaid Expenses 60,000
Total Current Assets 80,000

Current Liabilities
GST 2,400
Income in Advance 21,750
Provision for Prize Money 7,500
Provision for Grants 6,200
Trade and Other Payables 32,300
Total Current Liabilities 70,150

Current Ratio = 1.14
Quick Asset Ratio = 0.29
Cash Ratio = 0.29

A quick glance would indicate that this organisation can pay its short-term liabilities by liquidating its short-term assets. However, by looking at the Quick Asset and Cash Ratios would indicate it could only cover 29% of current liabilities if it had to liquidate its assets quickly, and this would not even cover the trade payables. The Quick Asset and Cash Ratios however do not look at the timings of the current liabilities in the calculation. In the above example in a ‘fire sale’ situation the Income in Advance contractually would not need to be paid.

The prize money provision was also payable towards the end of the 12-month period. The major creditor in the Trade Payables has, over a period of time, demonstrated they were lenient on enforcing payment terms. So, if I were to adjust the Quick Asset Ratio and Cash Ratio to reflect only the items that are immediately payable, the ratio would be 2.33 or 233%.

So, liquidity ratios are very useful, but require a little more skill in interpretation.

Most people in business are great at what they do, but when you talk to them about financial figures, they run for the hills. There are ten basic numbers and ratios every business owner just needs to know – and luckily, they are easy and quick. Don’t worry, I’m not trying to make you an accountant, but I am trying to give you a basic understanding of the financial drivers of your business.

First, a caveat – Never look at financial numbers in isolation. They should either be compared to the industry benchmarks and/or analysed over time as a trend.

Profitability Numbers

These are numbers, ratios and margins that tell us whether your company is making an adequate return. Adequate return is subjective – what is adequate to one person, one investor, one owner, one banker, or one industry?

Companies with a product or service that is easy to replicate or commoditise usually have low margins. Companies that have a competitive advantage or a barrier to entry usually have high margins. New products usually have a high margin to begin with, and as competition increases, the margin reduces.

1 Gross Profit Margin

This ratio tells us how much revenue is left over after paying for the product that generated the revenue.

Gross Profit Margin=Revenue less Cost of Goods SoldRevenue

In the example above 40% of the revenue is left over after paying for the product.

This number is important (and arguably the most important) because it will quickly tell us if there is sufficient revenue to cover the selling and administrative costs or overheads.

Increasing sales or revenues alone without understanding and managing the costs will create cash flow problems and make you unprofitable. Just looking at the Gross Profit Margin will quickly tell you if you are in a good position.

2 Operating Profit Margin

Operating Profit Margin tells us how much profit the business is generating after taking into account both the cost of goods sold and the operational and administrative expenses.

Operating Profit Margin=Gross Profit less Operating ExpensesRevenue

For sole trader businesses, I suggest excluding owners’ drawings, wages and expenses. For example, if you run a cafe excluding the owner-related expenses will give you a better picture, as if the cafe is generating enough revenue to cover its running or operating costs. If the owner decides to pay themselves too much and their costs are included in the operating costs, the picture the Operating Profit Margin paints will distort the reality.

Operating Profit Margin is often confused with the ratio below – Net Profit Margin.

3 Net Profit Margin

The Net Profit Margin shows the profitability of the business after accounting for all relevant costs. It also shows the return to the shareholder or owner.

Net Profit Margin=Net ProfitRevenue

This ratio should be analysed over time, and you are looking for a consistent and strong ratio. Deterioration over time may indicate a period of abnormal costs or conditions. It may also indicate cost blowouts.

The ratio should be compared to the industry and/or the shareholder or owner’s expectation of adequate return. A low margin compared to the industry indicates a margin squeeze and that productivity improvements or initiatives are needed. A shareholder or business owner should expect a return representative of the risk of the investment.

Activity Ratios

Activity ratios tell the business how efficiently they are using their short-term assets (especially cash) and indicate operational performance.

4 Working Capital (Current Ratio)

The working capital ratio can give an indication of the ability of your business to pay its bills.

A stronger ratio indicates a better ability to meet ongoing and unexpected bills, therefore taking the pressure off your cash flow. Being in a ‘liquid’ position can also have advantages such as being able to negotiate cash discounts with your suppliers.

A weaker ratio may indicate that your business is having greater difficulties meeting its short-term commitments and that additional working capital support is required. Having to pay bills before payments are received may be the issue in which case an overdraft could assist. Alternatively, building up a reserve of cash investments may create a sound working capital buffer.

Net working capital can also estimate the ability of a company to grow quickly. If it has substantial cash reserves, it may have enough cash to rapidly scale up the business. Conversely, a tight working capital situation makes it unlikely that a business has the financial means to speed up its rate of growth. A Working Capital Ratio greater than 2 is usually considered desirable; however, it is a matter of balance.

5 Debtor Days

Debtor Days indicate the average length of time it takes from when you make the sale to when you receive payment. This measures how quickly and efficiently a business collects its outstanding bills.

A larger number of debtor days means that a business must invest more cash in its unpaid accounts receivable asset, while a smaller number implies that there is a smaller investment in accounts receivable, and that therefore more cash is being made available for other uses.

Debtor Days should be looked at over time to see if there is a trend. A long Debtor Days may indicate that customers are struggling to pay their accounts, or lax credit monitoring. Economic factors such as a recession may lengthen Debtor Days and may require a tightening of credit control processes.

Lower Debtor Days numbers are generally better. However, a low Debtor Days compared to the industry benchmark may mean your credit terms are too stringent and that you are potentially missing out on sales opportunities.

It is a useful exercise to list your debtors and then order them by how outstanding they are. This is known as an Aged Debtor Report. This report divides the age of the accounts receivable into various buckets, which you can sometimes alter within the accounting software to match your billing terms. The most common time buckets are from 0-30 days old, 31-60 days old, 61-90 days old, and older than 90 days. Any invoices falling into the time buckets representing periods greater than 30 days are cause for an increasing sense of alarm, especially if they drop into the oldest time bucket. This report prioritises the debtors that need following up, and accounting software systems often will also provide the contact name, email address and phone number.

6 Creditor Days

Creditor Days indicate the average length of time it takes your business to pay its bills.

Again, this ratio needs to look at a trend and be compared to industry benchmarks. A declining ratio may indicate a worsening working capital position due to a decreasing stock turn or lengthening debtor days.

7 Inventory Days or Stock Turn

The Inventory Days or Stock Turn shows how many days it takes for the inventory to be sold and replaced.

For service-based businesses, replace Average Inventory with Average Work in Progress.
A low Inventory Days may indicate positive factors such as good stock demand and management. It also means fewer resources (usually cash) tied up in inventory. However, a too low Inventory Days may be a sign that the inventory levels are too low and unable to support an increase in demand.

A high Inventory Days may indicate that either stock is naturally slow moving or problems such as obsolete stock or good presentation. A high Inventory Days can also be indicative of potential stock valuation issues.

A caveat – Inventory Days is very industry specific. An industry where the inventory is not perishable or go out of date, it may be appropriate to have higher Inventory Days. Likewise, where the goods are imported, and it takes time to replace inventory, it may be appropriate to hold more inventory, such as cars.

Liquidity Ratios

Liquidity ratios measure the business’ ability to meet its short-term liabilities. They are especially important to banks and creditors when applying for loans or credit applications.

8 Current Ratio

Current Ratio is also known as Working Capital Ratio and is discussed above. It indicates if the business can pay off its short-term liabilities in an emergency by liquidating its current assets.

A high Current Ratio indicates a good level of liquidity but if the ratio is too high, it may indicate other problems. The inventory levels may be too high, valued incorrectly, or include too much obsolete inventory. There also may be a high debtor balance due to poor credit control or too generous payment terms.

9 Quick Asset Ratio

The Quick Asset Ratio gives a more conservative measure of liquidity than the Current Ratio. The Quick Asset Ratio excludes inventory as the value of the inventory that is realised in a ‘fire sale’ situation would be a lot less than the book value. It should also exclude any prepaid expenses.

In the example above, the quick Asset Ratio greater than 1 indicates that current liabilities can be met from the current assets without having to liquidate inventory.

10 Cash Ratio

The Cash Ratio is like the Quick Asset Ratio but excludes any other non-cash current assets such as Debtors. It is the most conservative liquidity ratio.

Construction has the highest rate of company insolvency actions of any industry in Australia. 

When you add in sub-contractors and sole traders, the construction industry accounts for over half of all insolvencies in Australia.

The high use of sub-contracting in the industry creates a unique challenge.  The client will enter into a building agreement with a contractor.  The contractor has the responsibility for all work on the project but may subcontract parts of it out.  A house build is a prime example where the client engages a builder as head contractor and then the builder sub-contracts various parts of the build.  It is estimated that 90% of the construction work is completed by sub-contractors. 

Cost control is hard because there is also a lot of estimation involved. Sub-contractors are usually small businesses, and the work they do for the head contractor is often a large proportion of their revenue.  Small businesses also have difficulty accessing funding and do not have large cash reserves.

With this structure, the whole construction industry is susceptible to a domino effect.  When a head contractor becomes insolvent, the reliant sub-contractors may also face insolvency, which then affects their creditors. 

There are several avenues that could be explored prior to formal liquidation. An informal restructure or turnaround may stabilise the business, look at different funding alternatives, and create efficiencies and positive cash flows – if action is taken early enough. Directors may also place the company into voluntary administration. The administrator would look to enter into a Deed of Company Arrangement with the creditors that would enable the company to trade out of its troubles.  

However, a far less-utilised alternative is the Safe Harbour provisions of the Corporations Act. When enacting the Safe Harbour legislation, the government said it was aimed to foster a business culture of entrepreneurship and move away from an environment that penalises business failure.

The Safe Harbour provisions allow directors to trade while insolvent if the director develops one or more courses of action that are reasonably likely to lead to a better outcome for the company. Each company situation is unique but generally, it depends whether the director:

 

1. properly informs themselves of the company‘s financial position
2. takes appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the company‘s ability to pay all its debts
3. takes appropriate measures to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company
4. gets advice from an appropriately qualified entity who was given sufficient information to give appropriate advice
5. is developing or implementing a plan for restructuring the company to improve its financial position

 

The Safe Harbour provisions only apply for the period that the Safe Harbour actions are being undertaken, and it is up to the directors to prove this in their defence of insolvent trading. It is also in the directors’ best interest to act early and implement and enact a Safe Harbour plan.   

There are several significant benefits of the Safe Harbour provisions for the company.  Control of the company remains with the directors, not the administrator, liquidator or receiver – all of whom work for the benefit of the creditors.  It is also a private action so other stakeholders need not know that the Safe Harbour provisions are being applied (unless required by other legislation such as ASX continuous disclosure rules).  Safe Harbour also does not have a legislated defined end date. Therefore, the Safe Harbour plan may go for many months, making it more likely to be successful.

  Because of COVID-19, the Australian government amended some of the insolvency laws to allow a period of trading while insolvent. In my view, this has – at best – just given companies in financial distress a bit of breathing space, but it does not resolve the primary underlying condition.

Construction businesses should investigate and consider Safe Harbour with other industry requirements. In Queensland, the licensing policy for builders includes the Minimum Financial Requirements (MFR) and Project Bank Accounts (PBAs). The MFR requirements are strict and therefore a company operating under the Safe Harbour provisions may not be complying with the MFR.  If the builder cannot hold a licence, the company would almost certainly be liquidated.  The PBA requires cash to be quarantined in a bank account and the builder will lose control, ownership and use of those funds.  Therefore, tighten the builder’s liquidity.