Practical advice for directors of distressed companies

Q: What are the most common signs a company is in financial distress?

The key signs of distress for most failing companies are deteriorating cash flow and working capital performance, as well as consistent underperformance against budget. In practice, these issues will often come to the board’s attention when it is clear that covenant or payment obligations are unlikely to be met.

Other warning signs include:

• disruption in the market or operating environment
• heightened competitor pressure
• changes in the cost base, such as increased wages
• errors in pricing or structuring of contracts with customers or suppliers
• time and/or cost overruns on major capex projects.

Q: When a company is facing financial difficulties, what practical steps should the board take?

The first step for any board of a distressed company is to ensure they have clear visibility of the cash position, sources and uses of cash. In distressed situations, we always recommend management prepare a detailed 13-week cash flow forecast to identify cash shortfalls in advance, and develop plans to address these shortfalls. This forecast should then be updated weekly to ensure the information remains current.

As part of this process, boards need to rigorously challenge management’s view of the business, their forecasts and any turnaround plans, to understand whether risks and opportunities have been appropriately identified and quantified. For example, considering whether the forecasts are realistic and consistent with recent performance. We often see forecasts prepared based on hope rather than reality.

Managing stakeholder relationships is crucial, and boards can assist with the management of key relationships, in order to preserve stakeholder trust and support for the company. For example, meeting with funders to discuss prospective covenant breaches well in advance of any issues, and letting them know what steps are being taken to address the issue.

Q: What reporting should the board be getting during this time (from management/independent advisors)?

There are significant personal liability risks for boards when governing distressed companies and we always recommend seeking independent legal advice to properly understand risks and obligations. To understand their exposure, boards should expect to be kept regularly appraised of the cash position and cashflow forecast, so they can monitor the solvency of the business. In a distressed situation, management should also prepare a robust turnaround plan that addresses the performance gap and assigns accountability to those best placed to influence the outcome. Boards should review and approve the plan, regularly monitor performance and be prepared to address any underperformance against the plan.

Q: What are some of the key benefits of engaging an independent advisor?

Boards should engage advisors to provide independent and objective guidance regarding whether the business can continue to trade and what options are available in the circumstance. Advisors play a crucial role in providing an objective view of the company’s position, challenging management’s plans, and advising on alternative options. KPMG are often called in by boards to support management with a turnaround, after management have made a number of attempts but need help to drive change. The earlier specialist advisors are called in, the more options are available to the board.

Q: From your experience, what distinguishing attributes do the most effective directors have in turning around a company?

In a distressed situation, the company can no longer operate subject to the status quo. Directors who are able to recognise issues early, and are prepared to make the required changes (often including bolstering or changing the management team), are critical to a turnaround.

Directors who understand the obligations and implications of financial distress are better equipped to develop an appropriate plan.

Q: What are common themes or issues that you have seen where companies have failed?

It is critical to act early and decisively to prepare and implement a restructuring or turnaround plan. We have seen many instances where a business could have been salvaged but the board and management have not reacted early enough or the changes have not been as extensive as they need to be.

Failure of the board or management to act decisively in these instances can mean that, by the time we get involved there are limited options available. By reacting early, the board can maintain control of the business and ensure they have a full range of options open to them.

Author: Leon Bowker, Director / Deal Advisory at KPMG

Published in Boardroom Aug Sep 2019  issue