Why businesses fail: ... and strategies for a successful turnaround.

As a turnaround specialist who has worked with companies of all sizes, from start-ups and stock exchange-listed companies, this experience has provided numerous insights on why businesses fail or simply stagnate. Ultimately bankers financing those companies wind up transferring troubled loans to "loan workout groups" (i.e. increased loan supervision) to attempt to cure the bank's concerns over increasing risk. While this course of action sometimes leads to rehabilitation, it equally causes the distressed company to go through a painful liquidation of corporate assets--and because such loans are generally collateralized by personal guarantees, also can result in a devastating liquidation of one's personal assets and self-esteem.

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Recognizing early warning signs

Professionals, including CPAs and consultants, often attempt to generically categorize business failures as a result of a poor business model, or inability to adapt the current business model to rapidly changing technology and forced to compete in a global business environment.

Entrepreneurial business owners typically become emotionally drained and are in denial during the survival stage, and are unable to implement required tactical measures needed to effectively move the business forward. Being able to recognize early common financial warning signs is a prerequisite to surviving the ups and downs of challenging business cycles and rapid, industry-wide landscape changes:

* Increasing tendency to heavily borrow working capital, including "temporary" overdrafts, to fund longer term needs such as replacement M&E to stay competitive--and/or finance losses, severely impacting available liquidity.

* Inventories and receivables growing without a corresponding increase in sales. Lack of attention to Accounts Receivable Agings and lack of maintaining current credit information on customers. The company's focus, even in troubled times, is geared toward increasing sales vs. getting paid in a timely fashion. Lack of sufficient information on inventory turnover (especially by SKUs in a manufacturing or retail business), and a reluctance to blow out stale (obsolete) inventories to generate cash for fear of generating declining profit margins, is an all too often occurrence. In the meat packing and rendering business, there is the applicable adage: "sell it or smell it."

* Lack of timely, monthly financial statements, including a Cash Budget, vs. relying on a daily checkbook management approach for dealing with the current cash crisis at hand. Abundant examples include myopic emphasis on meeting this week's payroll, avoiding COD shipments from a single source vendor, frantic covering of overdrafts and/or avoiding tax liens filed by the IRS or state for non-payment of FICA payroll taxes. This results in the lender losing confidence in the borrower and collateral backing the loan even when all interest and principal loan payments are made on time.

* Playing hide-and-seek from critical vendors rather than initiating open communications, including a survival plan which addresses vendor payment plans, even if this involves accounts payable restructuring. One client was entering its accounts payable by anticipated payment dates vs. by invoice date, thereby masking a true and effective A/P Agings to deal upfront with critical vendor payments and avoid being shut off. Another client relied on cutting checks to vendors but holding them from being released, ultimately paying the vendor who screamed the loudest and avoid being sent to collections. The result was a high book overdraft position on the balance sheet and a worthless A/P Agings that contributed to the company's serious cash flow difficulty. Continued delayed payments to vendors cause key suppliers to question a company's financial stability, creating a spiraling effect of CIA (cash in advance) and COD required shipments, and "temporarily" borrowing from the government via missed FICA payments.

* Employee crisis atmosphere. One product manager working in a troubled company compared his daily routine to swimming with piranhas, not knowing who in the company was going to extract a pound of his flesh for not making the correct decision in a cloudy decision-making environment. Solve one problem and two more immediately surface. Many decisions are delayed because of a top-heavy organizational structure in denial.

* Paternalistic ownership arrogance. An inherent laser-like belief that increased production and increased sales (typically referred to as obsessive growth at all costs) will overcome "temporary" losses and decline in margins vs. enacting deep and painful cost-cutting action steps.

* Imbalance in management talents of current team and lack of management depth, especially in the finance and accounting functions, to objectively deal with the business in decline and liquidity crisis. Many businesses are run by owners with a sales and marketing or engineering background. The finance function is often bypassed as being too costly. Entrepreneurs often scoff at the need for (1) generating timely internal monthly, comparative financial trends, (2) aging reports of receivables and payables that are consistently tied in with the general ledger (balance sheet), and (3) sub-ledger breakdowns for generating better expense breakdowns and detailed information on accruals and prepaid expenses. Generation of such financial information is often ignored by the business owner, except when the lender informs the owner the company is in violation of its financial loan covenants and the borrowing relationship is being moved to Loan Workout. In summary, the finance director, CFO or controller is all too often viewed as a glorified bookkeeper, hired to appease the lender's financial reporting requirements. When a borrower forms the conclusion that the lender is the principal cause of impeding the company's growth (self deception), it should be well understood that neither the lender nor the borrower profits from liquidation of the company's collateral.

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* Outgrowing the company's professional advisers. Frequently the company's CPA has centered its focus on offering tax advice, stripping the company of its net worth to effectively deal with unplanned economic and industry downturns. Examples include overly generous officer salaries, luxury company cars to reward the business owner(s), "temporary" officer advances not requiring FICA deductions, and investing in off-balance sheet investments of land and building whereby the owner receives tax breaks through depreciation expense, but stripping the company of increased balance sheet value over time. The company's business attorney may have advised the borrower on setting up an LLC (limited liability corporation) for a third-party related business entity to reduce financial exposure, but not addressing frequent advances to the related party investment, sapping the core company's liquidity.

Upshot: Ownership managerial arrogance, coupled with complacency and assuming the "ostrich position" to disguise and deny existing core problems, or viewed only as temporary, is a guaranteed prescription to lose the most important requirement needed to successfully emerge your troubled company from a crisis: your credibility, not only with lenders, but with vendors, customers and employees.

Tips on exiting 'The Treadmill to Oblivion'

1. Restore cash availability. While this requires various skill sets, a weekly cash budget must be generated with supportable assumptions. Restoring past-due critical vendor payments must be implemented, including open communications, accompanied with a credible plan to restore financial stability and reliability. Locked-up cash can be freed from focusing on collecting past-due receivables, instituting stringent customer credit limits and enforcing sales terms, and turning slow moving inventories into cash--even if selling at cost or below cost.

2. Construct a short-term (3 to 6 months) tactical plan and medium-term (one year) strategic plan to present to the banker on implementation of specific action steps, measurable objectives, time frames to complete and assigned responsibilities. The plan must address cost cutting, break-even analysis, customer and industry diversification if an issue (i.e., sales, customer receivables diversification), shedding unprofitable customers/product lines, restoring profitable higher margin business, and address deferred equipment maintenance causing quality concerns. The supporting financial plan should demonstrate adequate collateral protection to the lender, improved A/R Agings and collectibility for self help of accessing cash vs. the proverbial request to the banker, "If the bank would just advance additional monies to support our increased sales volume, everything would be just fine." Avoid relying on complex industry jargon in the turnaround plan, which ultimately makes it difficult for the loan officer to understand the basis of the turnaround and conveying the same to the bank's Loan Committee in seeking the requested and necessary credit approvals.

3. Institute a short-term vigorous planning process involving key managers. Ensure the objectives are measurable. This often represents a dramatic philosophical change of the entrepreneurial owner who characteristically has a feverish obsession of chasing disjointed, financial growth opportunities, not unlike the dog chasing its tail. Tactical and strategic planning is not the exclusive domain of publicly traded companies. The business owner must think beyond making short-term, immediate decisions to fundamentally address "can the business be saved and survive?" In understanding this approach, the business owner will still have to juggle daily crises that inevitably occur, but tactical and strategic planning will help restore credibility with the business' customers, vendors and convey to the lender(s) key decision-making action steps in the turnaround process.

4. Summon strength to ask for help. No matter how proficient the sales, technical and engineering expertise of the founding owner, the business owner of a troubled company must be able to come to grips with addressing key missing elements (typically financial) to reverse the stagnant and/or failing business. The business owner must also keep from being overly immersed in daily details and losing a sense of perspective of the overall strategy to measure improvement in overall operations.

Remedies: (1) seek the services of a qualified and experienced turnaround consultant in which to confide and objectively and systemically help to prioritize seemingly insurmountable problems, and be involved with corrective steps of implementation; and (2) institute an independent Advisory Board of Directors after the crisis to avoid relapse. The Advisory Board should review financial projections, focus on marketing initiatives, act as a sounding board for jettisoning complacent managers and employees and assist in finding solutions to time-consuming, mentally depressing business flaws. These tasks often are not as difficult as determining the nature and extent of the business' flaws and needed remediation.

A final reminder: Financial past successes often have led a company's management to follow the same comfortable pattern after the turnaround, even when continual changes are needed. A business owner cannot afford complacency. It will only lead to a new kind of disaster.

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These pages are brought to you by the Detroit Regional Chamber's Small Business Central ... the one-stop resource to help small businesses make money, save money and grow their business. To learn more about this initiative, visit www.detroitchamber.com or call (866) MBR-LINE.

Lawrence Gardner is president of Lawrence Gardner Associates Managerial and Financial Consultants in Troy, a member of the Detroit Regional Chamber.