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Turnaround Step One: Assess Your Financial Strength

A Stethoscope over a medical report form.A turnaround situation at any company, regardless of size, requires a candid assessment of the long-term financial well-being of the company. It’s important for outsiders considering investing or extending credit, and for insiders faced with formulating a turnaround strategy.
A necessary first step in evaluating a company’s financial soundness is getting the right questions asked and answered. You can look at the numbers and calculate a variety of ratios, but unless they are tied to specific questions and concerns, they’re not very useful.
Reality: Without a clear understanding of the right questions, the analysis will hinge on whatever information is readily available — which may or may not be accurate or realistic. The following questions are critical to a candid assessment of the future financial soundness of a company.
The key issues are whether or not the company’s goals, strategy, investment requirements, and financing capabilities are in balance. Note that these questions about financial strength apply to nearly any company, but are particularly important in turnaround situations:

  1. Will the company need to raise additional finance over the next year, and/or the next three to five years to carry out strategically important programs?
  2. What are management’s goals for the company? How does management plan to reach these goals?
  3. What investments must be made in working capital or plant and equipment to support the programs?
  4. How important is future access to finance from outsiders? Does the company have a seasonal or cyclical need for financing?
  5. Is the company profitable? If not, what does future profitability look like — and hinge upon? (Future profitability and positive free cash flows are essential to obtaining financing.)
  6. What are the underlying financial accounting practices? For example, are all subsidiaries consolidated? What lives have been assumed for depreciation purposes?
  7. Are there any “hidden” financial problems? Examples include suspiciously large levels buildups of accounts receivable or inventories relative to sales.  Unconsolidated subsidiaries with high debt levels? Lease commitments not shown on balance sheet?
  8. What is the historical trend in collection, inventory stock turn? Do the absolute levels seem reasonable?
  9. How soundly is the company financed, given its riskiness and need for additional finance? What is the maturity structure of the company’s debt? Is it faced with large debt repayments in the near future? Can the company service its debt? Is it close to borrowing limits in terms of bank covenants? What do the existing banking relationships look like?
  10. How current is the company in payments to its suppliers? Can key suppliers serve as a source of financing? Are terms open to negotiation
  11. Can the company raise equity funds? Is there a market for the shares?How many shares could be sold, at what price and to whom? Will management sell equity, and what control issues does that raise?
  12. Can the company raise long- or short-term debt? Who are the sources, and what criteria would apply? How much can be raised this way, and on what conditions? At what price? How well will the financing plan work if adversity strikes?
  13. Does the company have assets that could be sold to raise funds? Would a sale-leaseback be viable? How quickly could such sales take place?
  14. Are the company’s goals, product –market choices and strategies, investment requirements, financing needs, and financing capabilities in balance?
  15. What are the main regulatory, competitive, and operating risks? What combination of them might reasonably be expected to occur? (For example, supply-chain delays affecting production.) How would management respond in strategic and operating terms? What are the implications on future financial performance or financing needs?
  16. And finally, what about the management team? Who is “on board” and willing to help motivate and encourage top performance, from the top down? Who are the naysayers who might best be encouraged to find another position? Is the CEO the right person for the task at hand? This is critical. If the CEO is not a strong leader who drives results, the entity will not survive.

Clearly, many of these questions go beyond the information contained in the financial statements. Many require an understanding of (1) future industry economics and structure,(2) the competitive and operating characteristics of the business, (3) the long-term goals and plans of management, (4) the lending criteria of various capital markets, and (5) the soundness of management.

It is also clear that evaluating a company’s financial well-being can vary dramatically based on the perspective of the individual asking the questions. A supplier considering extending seasonal credit will have a different point of view than a long-term lender. That’s just one reason why the services of an experienced turnaround manager can help: He or she will have the ability to “package” a deal the right way.

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