As premier companies begin to wrap up 2017, FiZ turns its attention to the subject many firms often do not want to discuss. When EBITDA is positive and liquidity is great, few companies ever imagine what life can be like if they faced financial distress. Furthermore, financial distress is an often painful subject for employees of companies due to the constant belief that the going concern they work for will be an everlasting entity that will see them through till retirement. However, in the modern economy, the truth is that companies, during their life, will be faced with the question of financial health.
In order to fully understand the impact that financial distress can have on a premier company, it is important to understand the context in which financial illness can affect a company. Mckinsey provide a prognosis of what a distressed company can find itself dealing with. It categorizes the symptoms into four dimensions: Working capital and liquidity, Financial, Employees and Profitability and industry outlook.
An ailing firm, will experience symptoms in its handling of working capital when cash flow begins to decline and enters into negative territory. The cash flow and income statements provides evidence of this. The company can experience having large contingent liabilities and may be dealt with unresolved near-term debt maturities. Its suppliers may inevitably be force it enter into terms of payments in order to buy the company more time. This eventually leads to an increase in outstanding accounts payable.
Financial symptoms, for listed companies, are seen in a falling share price. They may also experience a decline in bank and bond prices. Banks become concerned when they observe that they are unable to meet debt covenants. They may experience an exodus of staff from the finance department who have had a keen eye on the numbers and know that the end is nay. With diminishing liquidity, the firm finds itself repeatedly seeking amendments with the banks in terms of obligations. This will subsequently lead to a downgrade in its credit rating. Reporting confidence is also diminished as the company continuously finds itself restating financials and subsequently not being able to file financial statements.
With reduced profitability and industry outlook, a shrinking EBITDA margin may inevitably entail that the company reduces on capital intensive programs. This is detrimental when critical revenue generating assets are at their epilogue due to depreciation. This then now raises the question of the viability of the going concern. Conversely, deteriorated industry fundamentals can inadvertently lead to an adverse regulatory environment. Therefore, it is no surprise when regulatory concern begins to be raised by stakeholders in/of that industry.
Debacle in human capital is the biggest signal of distress. Unplanned reductions of head count and management turnover are some of the consequences of distress. This is further exacerbated by a volatile union that may lead to industrial unrest that can affect the productivity of the firm. This is as a result of blotted administration costs on the income statement that drive up the cost of doing business.
Whatever the diagnosis, a management team faced with the aforementioned must act in order to save the company eminent demise. Turnaround strategies are often the preferred choice and require initiatives that are not only realistic but in the interest of restoring the firm to good health. These strategies will involve a prescription that includes the restructuring of any one of the following areas of the company: management, operations, assets and financial. Whichever the option, buy in and clarity on the part of the shareholders (and the board) must be in place because any one of the proposed areas will inevitably lead to an uncomfortable journey to recovery.