HOW TO IDENTIFY A COMPANY’S PROBLEMS

How to identify a company’s problems

Jean Chiasson CA, CIRP is a Partner of the Raymond Chabot Grant Thornton Turnaround and Insolvency group in Quebec City. More specifically, he practices in the corporate turnaround sector and is a member of the Turnaround Management Association. Jean Chiasson has a Bachelor’s degree from Moncton University (1985), where he earned the Governor General of Canada Silver Medal, and a license in accounting from the Université Laval (1986). His email address is chiasson.jean@rcgt.com

Just like ship captains, business owners should, at some point or another, expect to run into stormy weather. The risk level varies from one ocean to the next, as do the dangers. While sailing towards the next port of call, a good captain knows how to make use of his experience, crew and navigational instruments to spot the early signs of a storm. A captain is aware of the importance of listening to the external environment, in particular the weather forecasts and warnings issued by the coast guard. He knows where the safe harbours are and will dock there to avoid storms that he considers too dangerous. Lastly, he sees to it that his ship is equipped and his team prepared to face sudden damage.

Risk Level

Before the symptoms of financial difficulty even become apparent, certain situations require special attention owing to the specific inherent risks. Among these situations, we find:

1 A sharp increase in business volume

2 A series of acquisitions or expansion of activities

3 Changes in management methods or tools

4 A high debt structure

5 Family-business context

6 Industry that is cyclical or in chronic difficulty

Elements ‘‘potentially’’ related to such contexts

1. Sharp increase in business volume,

Þ Insufficient material, human and financial resources,

Þ Overcapacity of maximum production or service capacities,

Þ Real estate investment versus a temporary increase in sales,

Þ Pressure on employees and information systems

Þ Growth due to price discounts or decreases that risk compromising

Þ profitability

2. Series of acquisitions or expansion of activities,

Þ Expansion into areas where the company lacks knowledge and expertise

Þ New market potential below forecasts

Þ Excessive prices for acquired enterprises

Þ Expected synergies not realized

Þ Opportunities analysis or due diligence audit

Þ “Vision” versus strategic “error”

3. Changes in management methods and tools

Þ Lack of communication and training faced with new procedures and employee resistance to changes

Þ Inadequate implementation of a new computer system

Þ Problems related to the organization of production, shipping or invoicing

4. High debt structure

Þ Excessive debt ratio (>3.0:1)

Þ Non-compliance with default clauses on major loans

Þ Increased reliance on lenders

Þ Little or no manoeuvrability for decreases, even temporary, margin in profits

Þ Weakness in the face of competitors with greater capitalization

5. Family business context

Þ Decision-making affected by family issues

Þ Personal conflicts having an impact on the company’s business

Þ Unidentified, unprepared, incompetent or non-unanimously chosen successor

Þ Motivation of key employees who are non family members

6. Industry that is cyclical or in chronic difficulty

Þ Industry in a crisis (i.e., lumber)

Þ Industry in a downturn

Þ Industry known for its chronic difficulties (i.e. lack of resources, market competitiveness, etc.)

Þ Industry ‘‘spurned’’ by investors and lenders (i.e., high-tech, fishing)

Early signs of a storm

You will find hereafter a non-comprehensive list of the symptoms of financial troubles, taken from the course prepared by Raymond Chabot Inc. for the Ordre de comptables agréés du Québec:

Financial troubles

Þ Unfavourable financial indicators in the company’s balance sheet:

· Excessive debt ratio (>3.0:1)

· Working capital problems (i.e., liquidities, age of accounts receivable, inventories volume, age of accounts payable, etc.)

· Strong capitalization of intangible assets (i.e., R&D expenses, goodwill, deferred expenses, etc.)

· Capital financing from working capital

· Passed due government claims

Þ Downbeat financial indicators in the statement of earnings:

· Recurring operating losses

· Low profit margin

· Cumbersome fixed expense structure,

Þ Delays loan renewal processing

Þ Exceeding authorized credit limits

Þ Non-compliance with lenders’ financing criteria or default clauses,

Þ Non-compliance with payment agreements,

Þ Frequent and unnecessary delays in filing the monthly financial statements and

other management reports

Þ Incomplete, incorrect or non-existent management reports

Þ Insufficient financial and physical controls (i.e., cash, inventories, supplies,

etc.)

Þ Lack of budget-planning and monitoring process

Þ Financial results below budget expectations

Þ Earnings solely from extraordinary gains or non-recurring revenues

Þ Inability to obtain additional financing

Þ Recovery procedures by creditors

Problems related to the organization

Þ Debtor’s or key shareholder’s personal problems (alcoholism, drug addiction, gambling, depression, divorce,...)

Þ Frequent absences of directors during business hours

Þ Departure of key employees

Þ Aging product line

Þ Weak client diversification

Þ Lack of succession plan for management and key personnel

Þ Lack of strategic planning

Þ High quality of life of the principle shareholder

Þ Lack of external consultants and/or management committee, board of directors, etc.

Þ Tense work relations (i.e., conflict between key employees, strike, lockout, etc.)

Þ Reliance on suppliers

Problems related to the external environment

Þ Highly-competitive environment

Þ Highly-regulated environment

Þ Saturated or shrinking market

Þ Specific presence of aggressive competitors having marked competitive advantages such as size, financial resources, cost structure

Þ Specific industry events or contexts

Þ Precarious developments for the company (i.e., environmental issues, lawsuits, bankruptcy of a major client or supplier, etc.)