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7 Steps to Prepare Your Company for The Economic Storm
By Vistage
speaker
Edmond P. Freiermuth
When the economy takes a turn for the worse, executives need to embark on
two related courses of action. First, they should prepare their companies to
ride out the economic storm. Then, they should get ready to take advantage
of the recovery that will surely follow. This process requires seven
essential steps:
1.
Vigorously analyze your business
Get an accurate, up-to-date snapshot of your company's financial health.
Using a spreadsheet, pull together a comprehensive five-year financial
history of the business (paying special attention to the balance sheet) and
begin looking for trends in key financial ratios. Then, use a benchmark such
as the "RMA Annual Statement Studies" to compare your data to other
companies in your industry. If your trade association compiles performance
metrics for your industry, that’s even better.
When analyzing the data, pay close attention to the following:
-
Current ratio
-
Quick ratio
-
Debt-to-worth ratio
-
Return on sales
-
Return on assets
-
A/R turnover
-
Inventory turnover
-
Accounts payable days
The
direction
of these ratios tells you a lot more than the magnitude of the numbers. For
example, suppose your sales have doubled in five years but your leverage
(debt-to-equity) ratio has gone from 2:1 to 3:1. That may not be a healthy
trend. In fact, it could represent a serious decline in your company’s
financial stability. If your leverage ratio climbs to 3:1, or above, and
operating losses arise, bankers get
very
nervous—especially when credit is being restricted. The 5 Cs of credit are
back—Character, Capacity, Capital, Collateral and Conditions are old school
foundations of credit that have become fashionable again.
Next, compare your company's performance to the industry as a whole, again
looking for trend lines. If your industry has reduced leverage and increased
profits while you're going in the opposite direction, that sends up a red
flag of possible impending danger.
Search for signs of trouble within your industry. Is there excess capacity?
Are too many players offering prices that don’t allow most market
participants to operate profitably? Will further price erosion take place if
the industry revenues flatten or drop? The more danger signs you see, the
more likely that your industry could suffer during the downturn.
You should conduct this financial review and analysis on an annual basis.
During turbulent times, it becomes more critical than ever.
2.
Identify internal weaknesses.
During good times, companies hire too many employees, acquire too much
inventory and extend credit to customers with whom they should not do
business. When sales and profits start to fall, theses excesses become
painful. Look at every aspect of the business to identify internal areas of
weakness, including:
-
Over-staffing
-
Overly liberal credit terms
-
Too much or slow-moving inventory
-
Chasing revenues as opposed to profits
-
Increasingly aging accounts receivables
-
Declining quality standards
Identify areas to trim
before sales go flat,
so you can make cuts in a logical, rational manner. Avoid making
across-the-board, panic-induced cuts that endanger your core business. To
ensure your work force is productive, divide human resources into three
categories. "A" performers are motivated, highly skilled in their positions
and indispensable under all but the most draconian scenarios. "B" performers
are less experienced but "up-and-comers" able to handle new
responsibilities. "C" performers are able to keep their jobs only during
periods of strong economic growth. The split among these employees is
roughly 10%, 80% and 10%, respectively. You and your senior managers know
who the "C" performers are--or you should find out as soon as you can. They
are the ones who should be released if your business experiences ongoing, or
escalating, challenges. For most companies the largest expense is related to
employees.
3.
Develop a contingency plan.
Review Strengths, Weaknesses, Opportunities and Threats (SWOT) and consider
organizing a Profit Enhancement Planning (PEP) team. The PEP team will
likely find numerous cost containment opportunities. Talk about the changes
you may need to make and when you might need to make them. This should
include a combination of tactical and strategic planning that outlines
specific action steps your company will implement should profits turn to
losses.
4.
Create a worst-case cash flow forecast.
First, assume a 10 percent drop in sales and see how that impacts your cash
flow. For some companies, 10 percent may represent a conservative worst
case. If it looks like your industry will get hit hard, consider a forecast
with a 15-or-20 percent decline. Also, recognize that accounts receivables
will increase to some degree as customers begin having difficulties paying.
In short, get a clear picture of the cash receipts that are likely to be
generated over the next 12 months.
Second, calculate the total cash disbursements needed to run the business
and to service debt over the next 12 months. Assume that you will have
no
access to additional trade or bank credit.
Model your numbers to produce a positive cash flow. Make cuts in order to
ensure that money going out doesn't exceed money coming in. Don't make the
mistake of thinking you can increase revenues to cover cash flow shortages.
Your marketplace may not let you do so in a weak economy. Further, don't
look to your friendly banker to finance your cash flow shortfall. Instead,
focus on cutting costs so you don't run out of cash should sales take a
sudden downturn.
5.
Review the terms and conditions of your bank loan agreement.
Go over the specific terms and conditions of your bank loans, making sure
there is plenty of room to remain in compliance with all the covenants.
Strive for a 10 percent minimum buffer on every covenant in the loan
agreement. Don't get lulled into thinking everything is okay because your
banker hasn't called you in a while. Loan covenants give banks powerful
rights and remedies and during tough times they really tighten the screws.
Falling out of compliance causes the bank to reevaluate your firm’s risk
profile, which requires them to use more human resources to monitor your
company's performance. Your bank won't necessarily rescind the loan, but it
may use the situation to stiffen payment terms and ask for personal
guarantees. At a minimum, they will charge you (through higher rates and
fees) for the additional cost of doing business with you.
6.
Prepare an opportunity-based business plan.
Here's where you can shift from defense to offense. Companies with a healthy
balance sheet and strong cash flow can position themselves to acquire assets
and market share from competitors who find themselves in dire financial
straits. Such a strategy, however, requires a ready supply of capital,
which, in turn, requires a business plan that makes sense to your banker and
other sources of financing.
Your business plan should describe not just how you will survive an economic
downturn, but also how you will thrive and subsequently rebound.
Accordingly, the plan should include a combination of financial data
(including your worst-case forecast) as well as a strategy for acquiring new
business.
This kind of plan proves to your banker that:
-
You understand the current economic environment and are prepared to manage
your business accordingly.
-
You have the resources to survive the downturn.
-
You have a strategy and a plan for going after new business through an
acquisition.
Banks are becoming more picky about who they loan money to. If your company
is in good shape, you can go to your lender and say, "We understand the
business world has turned south, but we haven't and here's why." A
well-written plan gets your banker's attention and support. More
importantly, it helps your banker to be your advocate in the loan committee
so you can get the credit you need to finance your acquisition/expansion
plans.
Despite the current credit crunch, lenders are always searching for great
customers. This is a time to improve your position with your current lender
by introducing the element of competition. For well-run companies, this is
simply a matter of not turning away business other lenders who have been
calling on you before.
7.
Begin searching for opportunities within the industry.
Pay special attention to competitors experiencing financial difficulties,
but don't rush out to buy companies yet, as valuations tend to remain
excessive during the early stages of a recession. Wait until prices become
more realistic before implementing an acquisition strategy.
There are also opportunities to lay the foundation for expanding into new
products/marketing territories as well as begin searching for outstanding
hires in all key functional areas.
Remember: the more things change, the more they stay the same. Economic
corrections come and go yet companies continually fail to prepare for them.
If you have a well-managed company with good cash flow and a strong balance
sheet, there should be no reason for undue alarm. Now is the time to see
where you stand, take precautionary measures, and start positioning yourself
to take advantage of the opportunities to ride the next economic wave.
Vistage
Speaker
Ed Freiermuth
has more than 30 years' experience in financing and advising businesses of
all sizes. He has worked directly with the CEOs and senior managers of more
than 250 companies. As an independent business consultant, he works closely
with lending officers, attorneys, accountants, venture capitalists,
investment bankers and others seeking to resolve complex financial,
marketing and operational challenges. Ed can be reached at efreiermuth@gmail.com.
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