All companies experience liquidity problems at one point or another. A cash crunch is just part of the business cycle, particularly in industries such as retail and construction where seasonality is part of the way things are done.
But a liquidity crisis is amplified when business fundamentals begin to deteriorate, warns Rudy Morando, a Senior Vice President at Deloitte CRG, the Big Four firm’s corporate restructuring group. “During these times, it's more difficult to diagnose the problems."
“The scary thing is when management is in denial from admitting deteriorating fundamentals and keeps referring to [the reason] as seasonality," adds Sugi Hadiwijaya, also a Deloitte CRG Senior Vice President. "When CFOs know the difference . . . they’re positioning their companies for better liquidity during a crisis.”
The two US-based turnaround specialists engaged with CFO Innovation’s Cesar Bacani in an e-mail conversation. Edited excerpts:
In a turnaround situation, you advise management to press forward and not be afraid of making an imperfect decision.
Morando (pictured): In a true liquidity crisis, a company’s ability to quickly take action to stem cash burn and instill confidence in stakeholders is critical. Often, however, management sacrifices taking immediate action because of imperfect data. They’d rather wait until analyses are perfect before taking action.
"I would challenge CFOs to quickly identify their own company’s liquidity troughs and develop back-up plans to avert them"
But delay can cause more harm than good. It sometimes prevents a successful turnaround and often hurts the inherent value of the business.
Hadiwijaya: One of our past clients was a large chicken processing company in the US. When Deloitte was hired in late 2008, management was hoping for corn prices to be favorable before executing a turnaround strategy.
Feed prices skyrocketed in 2008 due to increased ethanol production [which use corn as raw material]. That had a big impact because feed accounts for 40% of a chicken company’s costs.
However, we decided to restructure the company through Chapter 11 immediately, instead of waiting for corn prices to be favorable. Today, the company has emerged from bankruptcy providing full recovery to all stakeholders.
Morando: A few years ago, I was an advisor to a US-based jewelry manufacturer. Historically, this manufacturer was a dominant player in the industry, exceeding US$1 billion in revenue per year. However, we were called in when the business shrunk to just US$150 million in annual revenues.
The business fundamentals were shifting and competitors were either being acquired or moving their workforces to Asia to benefit from lower labor costs. Our turnaround plan called for a reduction in force and a shift in manufacturing from the United States to Asia.
The CEO was fiercely loyal to his employees. His preference was to put the company up for sale, an effort that would cost him his job but hold the possibility of saving the jobs of the employees he cared about.
In the end, he sold the company at a time of distress, causing a lower sale value.
It’s difficult to fault the CEO for his decision. Unfortunately, the sale to a local competitor didn’t provide a long-term restructuring plan; it simply pushed the burden of developing the plan onto another firm and temporarily preserved the employment of his work force.
Following our strategy to shift manufacturing to Asia – while imperfect in his eyes – would have provided a better platform for a successful turnaround and a lasting business model.
Not all liquidity problems lead to, as you put it, a “true liquidity crisis,” right? How may a CFO distinguish between a temporary crunch that is caused by seasonality and one that is likely to be far more serious because it is caused by a fundamental shift in the business?
Morando: Large-scale liquidity challenges are typically caused by one of two things.
First, management didn’t have the foresight to see an imminent liquidity crisis caused by deteriorating business fundamentals or by an industry dynamic that unexpectedly changed. Second, management did not have the ability or time needed to bridge a liquidity trough.
While seasonality can place a short-term strain on liquidity for some industries (e.g., construction, retail), it is often understood and planned for by the respective business and their lenders.
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