WEALTH WARNING

You must not simply use the techniques outlined in this chapter to obtain more cash, particularly by increasing your borrowings or by taking further credit to stave off an inevitable collapse. If you do, as a director you will be running risks of personal liability for wrongful or even, possibly, fraudulent trading (see Chapter 11).

The purpose of this chapter is to help you to weather a cash crisis in order to put a turnaround plan into place, with some reasonable chance of success. If you are in a cash crisis and you have (or it would be reasonable to have) any concerns about whether there is any prospect of the business surviving, you must take professional advice to protect your personal position.

ACHIEVING BALANCE

In a cash crisis, your business’s short-term survival depends on you taking emergency measures to conserve and generate cash to buy time for longer-term issues to be addressed. Unfortunately, you may need to take action before making a full assessment of your business’s problems or before deciding on your recovery strategy. There is, therefore, always a risk that the short-term actions you take will be detrimental to your business’s long-term interests.

While surviving the short term must take priority at this stage in order to have a long-term future to worry about, where possible you should try to consider the long-term consequences and should adopt an approach that balances short-term survival with long-term regeneration.

Unnecessarily closing the factory you will need for your long-term recovery as part of your short-term cost-cutting plan tends to look not too clever in hindsight. But if it is a case of close the factory or go out of business, don’t hesitate – close the factory! Remember, you will not be around to worry about implementing your turnaround plan unless you have enough cash to pay the wages and suppliers this week and the next.

THE KEY STEPS TO SURVIVAL

A cash crisis can arise for a number of reasons, ranging from operating losses or the servicing of excessive debts draining the cash away to excessive capital expenditure or inefficient trading operations absorbing too much cash into illiquid assets, through to too high a rate of growth where the supply of cash is too slow.

To survive a cash crisis you must focus on some or all of the following key areas, although the steps you need to take will be determined by the underlying cause of the cash shortage:

• 1.Control the cash you have.
• 2.Get in more cash from normal trading.
• 3.Get in more cash or credit from elsewhere.
• 4.Reduce and/or control the cash going out.
• 5.Reduce the amount of cash you need to trade.
• 6.Improve profits.
• 7.Improve management.

Generally, the first five areas have quicker effects than the last two, and your cashflow forecast will show how pressing the crisis is.

One way to prioritise actions is to use a matrix such as the one shown in Figure 13 to plot your estimates of which actions will have the largest/fastest relative effects so you can focus on those that will make a real difference.

If you can demonstrate you can identify, face up to and deal with a severe cash crisis by taking the actions necessary to survive, you will increase your credibility with stakeholders (particularly your bank).

CONTROLLING THE CASH YOU HAVE

It is surprising how many businesses that are in a cash crisis fail to take the basic steps to control this scarcest of resources and to ensure it is used as efficiently as possible. First, prepare a cashflow forecast. From this exercise it will follow logically that, to manage the business’s cash efficiently, you should take the following steps:

• Centralise the control of cash receipts, payments and forecasting (and forecast daily on a cleared funds at bank basis). You can then prioritise and schedule payments so the available cash is best used for the benefit of the whole business rather than being used, say, by individual managers, sites or branches as they see fit.
• Roll forward the cashflow forecast on a regular basis, reviewing performance against forecast each time you do so to pick up any variances that need to be investigated or that can be used to improve the next forecast’s accuracy.
• Increase the level of authority required for purchasing or payments. Credit/charge cards should usually be cancelled or restricted so that cash is not wasted or committed outside the central forecasting regime.
• By preparing a cashflow forecast you may be able to identify where the cash is leaking out. Is it particular branches, sites or parts of the business? If so, target these areas for specific reviews and remedial action.

OBTAINING MORE CASH FROM NORMAL TRADING

You are likely to have a great deal of money tied up in debtors. As trading and sales become more difficult, many businesses feel less confident in demanding payment from customers for fear of losing future business, or are distracted from the day-to-day necessity of chasing in debts and, by default, they allow debtors to enjoy longer or more extensive credit terms than normal. This ties up vital working capital and is often the first place to look for funds.

Review the debtors ledger and take action to reduce credit terms to customers and to target and get in overdue debts. If as a result you find that credit control procedures or practices are poor, mark this as an area for specific action as part of your turnaround plan. In the mean time, introduce tougher credit terms for customers.

OBTAINING MORE CASH OR CREDIT FROM ELSEWHERE

Other than trading, possible sources of cash include selling assets, raising new borrowings or obtaining investment. Review the assets on your balance sheet to identify the following:

• Surplus fixed assets (land and buildings, plant and machinery, motor vehicles) that can be sold.
• Assets that could, potentially, be made surplus (and then sold) e.g. by subcontracting out your manufacturing processes.
• Essential fixed assets that can be sold and leased back to provide cash while still being used.
• Under-utilised plant and machinery capacity that can be hired out, or spare factory or office space that could be sublet.
• Separable and saleable investments, subsidiaries or any parts of your business (e.g. a specific branch).

Is there any equipment lying around (that might not even be on the balance sheet) that can be sold? You might be able to use asset-based financing (including factoring or discounting your debts) to obtain more borrowings against your assets than are available from your bank under its debenture values as outlined in the briefing on pages 90-92.

Do you have any unpledged assets that can provide security for new loans, such as brands, trademarks and other intellectual property rights?

Using your cashflow forecast, seek to negotiate an extension of your existing bank facilities or other borrowings to cover the forecast requirement. If appropriate, seek to agree deferment of loan

repayments or to roll up interest for later payment. If seeking to borrow further funds, always consider carefully your business’s ability to meet the payments in both the short- and long-term before taking further money. You do not want to dig yourself deeper into debt you cannot afford to service.

Agree new stocking arrangements with supportive creditors (such as sale or return, or pay when paid) or agree longer payment terms. Ask customers to supply free issue stock for you to work on so you do not have to buy in materials. Seek injections of capital from shareholders or directors (the bank may well put pressure on you for this to happen in any event as a sign of your commitment to the turnaround, as well as to reduce its exposure).

If you are asked to make a further investment in a business in difficulty or to guarantee personally further borrowings for a company, it goes without saying that you must look very carefully at the commitment you are making, the likelihood of recovery and the impact it will have on you should the business fail. You should always consider getting professional advice in these circumstances.

You could seek an injection of equity into the business from outside investors. However you will need to appreciate that any such investor is likely to place little value on the company as it is, will want to move swiftly and will generally want to take a very ‘hands on’ role. You will however need to be wary of both ‘vultures’ and time wasters who are not really serious about investing in a turnaround situation when it comes to it so ensure that you have good advice. Turnaround Equity Finder (www.turnaroundequity.co.uk) provides a swift, confidential and cost effective means of circulating turnaround investors nationally.

REDUCING AND/OR CONTROLLING OUTGOING CASH

As with all things in life, what we don’t spend, we keep. Cancel discretionary expenditure, such as the payments of dividends. Cut back or cancel the following:

• Advertising/marketing, but assess how immediate the link is between this and sales, and do not cut advertising that is vital for short-term turnover.
• Training, but retain any training necessary to meet statutory requirements.
• Research and development, but assess the risk you may run of losing any key projects or staff that are vital to the long-term recovery plan.
• Capital expenditure, but assess how vital any such planned expenditure is to improving profitability in the short-term or to the long-term turnaround plan.

Increase creditor payment periods through agreement with suppliers. Negotiate scheduled payments with your key creditors, the Inland Revenue and HM Customs & Excise (an ‘informal arrangement’). If agreeing scheduled payments with suppliers, be clear as to what proportion of the payments made is going to be used by the supplier to reduce the total amount you owe and what proportion will be used to allow further supplies on credit.

Consider using an Insolvency Act procedure (see Chapter 2) to obtain protection or agree a formal binding deal with creditors. (Try www.turnaroundhelp.co.uk for a local advisor). Consider whether any key creditors might be willing to convert their debt to shares in the business (’debt for equity swap’), if this is acceptable to the existing shareholders. In the right circumstances, some banks will consider such steps. Others will not.

Pensions

In the aftermath of the Maxwell affair, the regulations to protect employees’ pensions have become more stringent, with strict duties and timescales imposed on companies to pay employer and employee pension contributions to the relevant pension schemes.

The different types of pension schemes in operation today make this a complex area, but the following general rules must be applied: always pay over employee contributions deducted from salaries and always obtain professional advice on any proposal to reduce employer contributions before making any change.

Under the new Pensions Act, the Pensions Regulator can impose contribution notices on individual directors for any action taken (or that they failed to take) which results in a deficit in a defined benefit (also know as a final salary) pension scheme. Additionally they can impose financial support directions where other members of a group of companies can be ordered to support a deficit in a defined benefit pension scheme.

The sums involved can be significant as the scheme’s liabilities will be calculated on a ‘full buy out basis’. This will normally be much higher than the minimum funding requirement (MFR) used to calculate the company’s normal ongoing contributions. At the time of writing one case is being reported where the deficit on an MFR basis is some £3m while under new accounting rules coming in it is closer to £500m and the full buy out value is higher again.

As new accounting standards will require companies to disclose these liabilities as part of their results, it seems likely that this may cause some publicly quoted companies considerable problems.

REDUCING THE AMOUNT OF CASH NEEDED TO TRADE

Your ‘working capital cycle’ should be a virtuous circle generating cash (see Figure 14). Whether your working capital cycle requires funding is determined by your actual terms of trade with suppliers and customers. Reducing the cash tied up in the cycle means that what cash you do have can fund more trading.

Example

Company J deals with only one item at a time, and its current transactions are summarised below:

01/01 Purchases a widget for £100 on one month’s credit

31/01 Pays supplier for widget

28/02 Sells widget at 200% mark-up on one month’s credit after normal two months in stock

31/03 Customer pays £300

Plotting these transactions over time we can show how the borrowing requirement to fund this working capital cycle is £100 over two months (Figure 15). A bank will see this as an appropriate use of an overdraft facility, which will swing back into credit as the transaction unwinds into realised profit and cash. However, in practice, Company J will need to agree the facility in advance with the bank and it will need to offer some other security (such as personal guarantees) as the bank will be unlikely to lend against 100% of stock value without this.

You can also see that Company J could reduce its borrowing requirements to nil by changing its trading arrangements. For example, it could reduce its investment in stock and debtors:

• If it bought in the widget only when it had a firm order and could ship it straight out (a ‘back to back’ deal), the debtor would pay at exactly the same time as the creditor was due.
• If it stocked only what it could sell in a month for cash.

It might also replace bank lending with supplier credit by taking three months’ credit that would match the date of receipt and payment. It could also adapt a mixture of these two approaches, e.g. take two months’ credit from suppliers and stock only items that sell in a month.

Even if it implemented any of these, Company J should still negotiate a bank facility as insurance against any unforeseen cashflow problems.

You should look at all aspects of your working capital to see where there is scope for a reduction:

• Reduce finished goods stock (e.g. by a sale of slow-moving or old items), but be careful with such strategies and consider the risks and consequences (e.g. is dumping stock in your normal markets going to spoil your efforts to increase normal sales?).
• Complete work in progress and turn it into sellable, finished goods as soon as possible.
• Review your production management, particularly if you are building, say, batches of subassemblies. Does this mean you are deliberately tying up cash in parts that will not become finished goods for a long time? Can you move to just-in-time production?
• Cancel or reduce any outstanding raw material orders, as long as this does not give you a contractual problem or unacceptable risks of stock-outs.
• Return any unnecessary stockholdings to suppliers, either by agreement, by moving on to a consignment stock basis, or by stepping up your quality control standards and checks.

IMPROVING PROFITS

To improve profits fundamentally requires achieving some combination of the following, depending on which area is most responsible for the problem:

• Increasing turnover by increasing some or all of customer numbers, value of spend per customer or frequency of spend.
• Increasing margins by reducing costs of sales.
• And/or reducing overheads, including dealing with any nonperforming parts of the business that are dragging the rest of the business down.

In a cash crisis, the short-term practical steps tend to focus on cost reduction.

Increasing turnover

Can you raise prices? However, first check how sensitive your sales volume will be to price. If you produce a ‘commodity’ (e.g. pencils), customers will tend to buy largely on price. As they can obtain exactly the same thing from Joe down the road if he is cheaper, raising prices above market rates will lead to a major loss of sales. If your product or service is ‘differentiated’ (where customers cannot buy exactly the same thing from Joe), the position is a more complex question of perceived value, and you must judge how much you can increase your price before customers decide that Joe’s cheaper product will do well enough for their needs.

What opportunities can you identify to increase volumes quickly, cost effectively and relatively certainly by attracting more customers, getting them to come back more often or to spend more while they are buying from you (e.g. do your staff ask whether customers want a new oil filter when they come in to buy oil)?

Increasing margins

Identify the key constraints on your business (e.g. we only have one XYZ machine, which is a production bottleneck) and ensure that profit is maximised for that constraint (i.e. we should seek orders for product 1 as we make more money per hour of XYZ machine operation than we do by producing product 2).

Improve your productivity/output by looking at your processes, but solutions requiring capital expenditure (e.g. increased automation) tend to be long-term issues.

Improve your efficiency in your control of purchasing, distribution, contract control, quality assurance or waste management. Look for any opportunities to reduce the cost of goods sold (e.g. reduce raw material prices, reduce scrap, change materials, lower the labour component).

Reduce wage costs by introducing short-time working or a redundancy programme (compare your head count to competitors’ or to that of two or three years ago), but be careful to ensure this is understood to be a short-term step and do not preclude the need to make further long-term changes.

Redundancies

When making redundancies you must meet current standards and legislation in respect of:

• consultation with employees;
• the grounds for redundancy;
• the selection of employees.

It is best, therefore, to obtain up-to-date advice from your solicitor.

You will also need to fund any redundancy payments required. In some circumstances, the DTI’s redundancy fund will be able to grant you a loan with which to fund the payments, and you should contact the DTI to find out what assistance is currently available.

Reducing overheads

Can you reduce manufacturing overheads? Are your selling, general and administrative expenses in line with industry standards? Can you look for savings in some of the following areas:

• Management salaries – should you ‘share the pain’?
• Premises costs – can you consolidate and lease out extra space?
• Vehicles – can you eliminate the car fleet or have your employees bear the costs of cars?
• Professional costs – can you reduce the costs of accountants, lawyers, etc.?
• Postage – do you really need overnight couriers, etc.?
• Telephone costs.
• Advertising and promotion costs – is your advertising cost effective? Is it an investment in the future or a necessary expense for obtaining sales in the short term?
• Selling expenses – can you cut the size of the salesforce or the number of sales offices without significant short-term costs?

Consider closing or selling any of your business’ subsidiaries or branches that have net cash outflows or that are unprofitable (but see Chapter 7). Rationalise your customers, products, prices, processes and funding.

IMPROVING MANAGEMENT

You need to look at whether you need further management expertise. Do you need a finance director to:

• Provide strong guidance in respect of your strategy?
• Provide financial advice on major decisions?
• Liaise with your bank?
• Prepare regular cashflow forecasts and budgets, including profit and loss accounts and balance sheets?
• Assist in preparation of feasibility studies on major development projects?
• Integrate accounting systems as required and install adequate internal controls?
• Plan your tax strategy to minimise tax costs?
• Oversee the company secretarial functions?

Do you need to change your management structure, incentivisation or culture (see Chapter 10)?