Compartmentalizing your distress is risky business

Effective financial management underpins the success of any company, regardless of its size. Unfortunately, many business owners are so focused on this growth that they fail to recognise the need for their accounting processes and systems to evolve with the increasing business.

Despite the best intentions, this can be a contributing factor towards the company becoming financially distressed and ultimately reaching out for business rescue.

The Pillars of Effective Financial Management

Financial management encompasses planning, organising, directing, and controlling resources within an organisation, and this is where budgeting and forecasting play a crucial role. If managed correctly, sound budgeting and forecasting are valuable tools in managing and directing the organisation towards its strategic priorities and objectives.

In addition, managers within the business need to understand how profits and cash flows are generated within the company. Similarly, costs that are committed to by the business need to be thoroughly understood, closely controlled and managed in line with affordability and the budget.

A deficit of proper planning and financial management often results in a lack of visibility into the company’s immediate situation and its challenges. This is a critical point for the business, as the managers and leaders will not receive accurate information to allow them to take the essential decisions needed to steer the company back on track.

It can then be seen that financial distress is a direct result of the decisions made or not made within the business. Informed decisions can only be made based on valid, accurate, and relevant financial information, allowing the business to act on potential opportunities.

Distressed Business Should Avoid Falling Into The Panic Trap

When faced with challenging business circumstances, it is crucial for business owners to identify the most critical strategic objectives. As Peter Drucker put it, “Management is doing things right; leadership is doing the right things.” Having the right systems in place will ensure that the management is doing things right. This becomes even more crucial when it is mission-critical. In a panic situation, distressed business owners make several common mistakes to try and correct the company’s financial situation. These mistakes are often the result of a number of factors.

Pressure from the shareholders

CEO’s of distressed businesses are under immense pressure from their shareholders and debt service providers to deliver positive results. As a result, the true picture of the financial performance and position of the business is not always accurately represented.

When the reality of the situation is finally fully understood, this can lead to a breakdown of trust. Obtaining an accurate understanding of what the commercial and financial realities are is crucial for determining what the next steps should be.

Absence of a turnaround plan

Once leadership and management are clear about the financial and commercial realities, a clear plan should be developed, initiated, and monitored.

This plan needs to include measurable financial and commercial metrics that are monitored and reported upon regularly. If you can’t measure it, you can’t improve it.

Lack of suitable accounting systems

Any successful business must have reliable systems in place to drive its operations and strategic growth objectives.

Having relevant systems in place will provide accurate and reliable data to ensure a consistent level of service through stable operations and business processes. It will also enable the business to manage its employees’ productivity more effectively and ensure that the relevant tasks are being performed correctly. 

Speed is of the essence

The speed at which decisions and actions are taken is vitally important during a distressed situation. Leadership and management must maximise the opportunities available whilst taking swift action on their findings.

Cash flow issues

In an article that focused on the Basil Read business rescue, Siviwe Dongwana, MD of Adamantem, pointed out that cash flow leaks are among the primary causes of the construction giants who find themselves in financial distress. 

Cash flow leaks are a common contributing factor for businesses becoming distressed. It is therefore vital that the company leadership understands what the required cost structure of the business is. This should be defined within a budget and regular forecasting management. Part of management’s responsibilities should be to manage their respective areas within an approved budget.

Unfortunately, it becomes easier to perform without the pressure of cost constraints than with such restrictions being in place. For example, achieving production output targets is sometimes more straightforward without considering the amount and value of the inputs required for the production process. As such, the inefficient use of resources has a direct impact on the cash flows generated. Cash flow management and cost control in the context of the commercial and operational requirements are crucial to manage and control.

Pay the piper

The classic tale of the Pied Piper of Hamelin demonstrates the importance of paying the piper, or in this case, to keep up with payments to creditors. Creditor management plays a vital role in any business. Too often, poor creditor management is at the root of distress for many companies. An example of this is CNA – a business rescue currently receiving a lot of press. Of particular concern, in this case, are reports that the distressed company’s creditors have not been paid in many months – some dating as far back as January 2021.

Keeping up to date with payments to creditors is further highlighted by the fact that creditors pretty much dictate the rules of engagement when it comes to the approval of a Business Rescue Plan.

The role of creditors during financial distress

Having the correct networks are vital to the success of any business. A business’ creditors are the provider of the inputs into the business, whether they are the supplier of products or services. Creditors are, therefore, a vital part of the network of a business. As such, abiding by the established credit terms has a direct impact on the products and services that are sold to customers. Furthermore, a company’s reputation with its creditors, as the stakeholders in the business, becomes more relevant in a competitive market. Therefore, every effort should be made to manage the relational capital with the business’ creditors.

Approaching the entire business ecosystem

When a company is approaching financial distress, it is often easy to compartmentalise the distress to address challenges systematically and logically. The challenge of this approach is that business owners and management can become so focused on one challenge that they ignore other crucial aspects and challenges that impact the root cause of the company’s financial distress.

Company owners need to pay attention to the whole business ecosystem, which includes the financial management of the business. A lack of sound financial management can place a company in distress. Objectivity adds significant value to a company which is why companies facing financial distress should consider employing the services of an independent business advisor.

A business strategist and advisor can independently assess the company’s financial landscape and provide an objective opinion on the current state of play while highlighting potential blind spots that could develop into challenges. 

Javan Cloete is the Director of Boutique Advisory

This article is a general information sheet and should not be used or relied on as financial or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE).

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