Cash Flow Problems – Financial Distress 7/8

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In the seventh of a series of eight blogs, our banking experts are looking at common cash flow problems that businesses encounter. In this penultimate blog, Colin Burns discusses what can happen when a company finds itself in financial distress, and if the signs are ignored, bankruptcy could follow.

What causes financial distress?

Several factors can lead to financial distress, including company under-performance, high fixed costs, competitor disruption or a downturn in the economy. And when this happens, it can be all too easy to bury your head in the sand and hope the problem will solve itself.

A company may face financial distress of its own making. It may employ unproductive employees, run high capital projects at the wrong time, take on expensive financing costs or simply have a poor sales and marketing strategy.

Companies may also become financially distressed due to external market forces. For example, disruptive competitors offering better products or services at lower prices. An economic downturn – such as the COVID-19 crisis – is even more likely to bring financial distress.

Distressed businesses will typically see their sales rapidly decline and find suppliers offering less favourable terms. It may become harder to secure financing and employees may suffer from lower levels of morale.

Left untreated, a company in financial distress faces a high probability of bankruptcy. So why risk losing a business that you have put everything into growing?

What are the key indicators?

The following financial indicators can help you identify if you are in financial distress, enabling you to spot warning signs and prevent any long-term damage to your business:

  • Increasing number of unpaid invoices.
  • Lower revenues, increased costs, lower margins.
  • Declining gross profit margin and operating profit margin.
  • Changes in gearing/leverage and debt/asset cover ratios.
  • Changes in CFADS (Cash Flow Available for Debt Service).

When faced with a business in financial distress, these are the steps that key stakeholders within your business should take:

Role of the MD/CEO

The MD needs to take control of the emerging situation by:

  • Validating whether the business can realistically meet debt payments on time.
  • Conducting root cause analysis as to which variables have changed since debt was taken out.
  • Understanding if the problem is marginal or temporary and if the situation is worsening or improving.
  • Evaluating if the problem is due to insufficient growth or over forecasting.
  • Validating whether the business would remain viable given a different capital structure.

Role of the FD

The FD needs to take responsibility for identifying internal and external solutions to protect cash flow by:

  • Regularly monitoring and analysing KPI performance against forecasts and reporting this to the MD.
  • Identifying key trends and flagging problems early to enable remedial actions.
  • Re-forecasting based on current and emerging trends to assess how quickly the business could face serious problems.

Role of Ops/Sales

The Sales and Operations teams need to support the MD and FD by:

  • Working with the MD / FD to implement remedial actions for performance improvement.
  • Re-prioritising high capital activities in favour of more profitable ones.
  • Evaluating marketing strategy and developing the proposition to make it more competitive.
  • Identifying cost cutting opportunities across the organisation.

Key points

If the core business remains viable, identify what capital structure the business could support with its current assets and profitability. Evaluate if the gap can be bridged with current capital providers through collaborative restructuring or identify if the business can be refinanced by a more suitable capital structure.

If the core business is viable but over leveraged, evaluate what recapitalisation options are available and the impact each has on existing debt repayment and owners’ equity. Finally, evaluate whether the situation requires pure debt restructuring or if major operational changes will also be needed.

I hope this blog has provided some useful tips on what happens when a company is in financial distress and how your teams should work together to avoid bankruptcy.

If your business is facing a similar cash flow situation, please do feel free to contact me, I’d be delighted to help.

Colin Burns – Director, Shaw & Co

Colin is a Funding Advisor at Bristol-based Shaw & Co. He is part of one of the largest corporate finance advisory teams in the South West. He is a fully qualified Chartered Banker and Green Finance Certificate holder. Over the last 15 years he has arranged facilities in excess of £250m in over 20 MBO transactions including small owner managed businesses and listed corporates.