Article
Recognizing early warning signs: When to prepare for a corporate turnaround
One of the unspoken job requirements for corporate leaders and investors is to project confidence—even in times of uncertainty. But in today’s rapidly evolving business environment, many executives, board directors, and investors quietly harbour doubts about how their company and investments might perform. After all, it feels like we’re always in unprecedented times these days.
The list of potential business threats and challenges is long, and seems to grow every week: high inflation; rising interest rates; the looming spectre of a recession; tight employment markets; challenging supply chains; near-shoring; friend-shoring; crop failures; eroding consumer spending; the need to go green; environmental, social, and governance (ESG) pressure; the broader adoption of artificial intelligence (AI); and new disruptive competitors. Regardless of what industry you’re in, it’s possible to identify several challenges that directly affect your business.
Such challenges and their accompanying uncertainties can expose a company’s weak spots. When left unaddressed, weaknesses can lead to declining performance, which can lead to liquidity challenges, which can trigger a downward spiral that destroys both profit and value.
As the number of warning signs grow, problems materialize and companies start to struggle, diverting the focus of their executives, board members, and investors away from creating profit and value. It can become more difficult to properly identify and act on performance issues. This is where a turnaround can be an effective way to stop the downward spiral. Engaging an experienced turnaround advisor can bolster the skills of a management team that traditionally focuses on growth and expansion. Turnaround professionals are experienced at triaging tricky situations and operating during periods of uncertainty, with a primary focus on arresting decline while simultaneously identifying opportunities for improvement.
More often than not, warning signs are ignored or remedial actions are not maintained, leaving management teams sidetracked by critical day-to-day issues. In addition, business leaders are generally optimistic, tending to believe that their work will improve the company’s situation and the tough times will pass. Most restructuring advisors who have experienced a messy turnaround say that they wished the company called for help sooner because they now know that it would have provided them with more options, resources, and time to alleviate the situation.
Fix before the fall
The history of global commerce is littered with examples of companies that failed to make the right moves early enough. Oftentimes, management doesn’t have the experience—and perhaps more importantly, the objectivity—to engineer a successful corporate turnaround. Even in good times, leading a company is not plain sailing; navigating through stormy seas is always significantly harder.
A turnaround isn’t a restructuring, despite what many people think. Instead, it’s a process that helps stabilize the business financially and identify underlying strategic and operational changes that should be made with the aim of returning the company to profitability.
Typically, a company will realize that something is amiss when it breaches a debt covenant, is struggling to pay its bills, or experiences other liquidity issues. When nothing is done to fix the underlying foundational issues, the business may be able to continue to operate for a while, but it could also be heading down the long shadowy path to insolvency.
Taking action early gives a business the best chance to correct course and maintain the support of its stakeholders. A return to the growth and expansion phase that leaders, board directors, and investors expect comes from addressing the underlying issues that are affecting liquidity. It’s never too early to start a discussion with a qualified turnaround advisor, even if their services aren’t required immediately. A turnaround advisor can help with an early assessment of where the business is likely to experience stress and how to recognize the early warning signs so timely action can be taken.
Five early warning signs
1. A loss of focus on the big picture
Due to the day-to-day running of a
business, executives tend not to sound the alarm bell when they should, especially when their
business is under financial strain. This leaves them focused on the minutiae and not on the big
picture.
2. Profit and cash flow aren’t keeping up with growth
Underlying business process
flaws are often masked by growth. There are countless situations where companies grow, but don’t
generate commensurate increases in profit and cash flow, which can lead to a liquidity event.
Management is often taken by surprise because expansion is typically equated with success—and
there’s an unrealistic expectation that growth at the top line will drop to the bottom line.
3. A lack of capital investments in the business
Another way that growth will
sometimes harm a business is through capital investments, such as new machinery, additional
employees, working capital, software, or other assets to expand capacity. Understanding how these
investments can create profitable growth is critical. Following up on these capital investment
decisions is crucial, as is setting up timely reporting to better understand whether the investments
are earning a return and how they are impacting the company’s top and bottom lines.
4. There’s no strategic plan for the current environment
During the last
decade, operational and strategic shortcomings have been obscured by inexpensive financing. Even if
a company wasn’t particularly profitable, it could still manage cash flow because of low lending
rates. Now, with higher borrowing costs, it may be more difficult to access capital and reduce or
service debt. It can be even harder if the entire industry is being disrupted and the company is not
the industry leader. Assessing capital structure and ability to service debt with future cash flow
is an important exercise that should be performed regularly.
5. The business is slowly declining
Financial deterioration may be the most
common sign of problems, but there are other important flags to look out for, such as a gradual
build-up of inventory, increasing operational issues, or a decline in certain key performance
indicators, especially liquidity indicators. Businesses might also experience a prolonged decline in
customer retention, escalating staff attrition and skills erosion, and longer accounting cycles,
which all make it more difficult to judge business performance. Regardless of the symptoms, many
companies don’t have a good way to diagnose their issues objectively and feel that they must attempt
to solve them on their own. A strong turnaround advisor can help them assess their business based on
three pillars: strategy, finance, and operations.
Stay out of survival mode
Monitoring and acting on the early warning signs can help prevent liquidity issues that can destabilize a business. Once a company encounters a significant financial issue, it often becomes distracted with trying to keep operations running, despite not having enough cash. This inevitably leads to other problems, such as losing focus on operations and what makes the business profitable.
What starts as a financial problem can also become a communication crisis. Customers, bankers, investors, and employees become nervous, which forces the management team to spend more of its time calming down and managing stakeholders.
If executives are busy smoothing out liquidity bumps, they can’t focus on growth, improving performance, or turning investments into the actions that can help transform their business. So, what should they do?
The anatomy of a turnaround
One of the most effective ways to halt any downward cycle is to identify the early warning signs and take action. Management teams are typically focused on growth, but sometimes the focus needs to shift to preserving cash in situations where performance is declining or there are gaps in the finance and operations team. In these conditions, consider bringing in an experienced turnaround specialist such as Deloitte. We can work with your management team to triage your business situation and help your management team take decisive and rapid action to address the situation objectively.
Our seasoned professionals understand your business, your industry, and your specific challenges. Deloitte can help you navigate a turnaround, deliver measurable results, and take the right steps to alter the trajectory of your business.
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