By Mubarak Sooltangos
The turning around of a company with dwindling or complete loss of profitability is very often beyond the capacity of the normal business driver, otherwise he would have taken timely steps to prevent the downturn. This turn around and salvaging operation is often entrusted to consultant firms. Consultants with an accounting background have a standard set of measures which can be effective in giving short-term equilibrium to the profit and loss account, but which is detrimental to the company in the medium term.
The cost cutting strategy and staff lay off syndrome
Accounting professionals invariably have the reflex of looking at costs as a priority. In eight out of ten cases, the first costs which they tackle are staff costs, because it is an easy task, but this gives rise to several drawbacks. In the laying off of staff motivated by purely financial logic, the most common practice is to go by the “last in first out” principle. This consists of making staff with short lengths of service redundant, in order to pay lesser severance compensations. Consultants forget the fact that they are laying off young people who represent promises for the future and keeping in place older staff who probably are at the very root of the bad performance and the profitability problem.
In their redundancy program they will also target low performers, which is not irrational. In the meantime, good performers would be asking themselves the question of whether they are next in line. They will start looking for alternative jobs elsewhere and they will be successful in this attempt because of their track record. While the end goal of saving a company by staff redundancy may finally be achievable, the very first step which is taken is one which leads to misery. Human feelings and considerations are completely left aside, overlooking the trauma which is being undergone by a head of family losing his job and having at the same time to ensure the upkeep of his family and the servicing of housing loans and other credits he may have taken. We can add to this trauma the impossibility of a relatively unskilled employee, like a store keeper, having reached 45 years of age to find an alternative job.
Alongside this, they will also eliminate staff benefits, which is highly demotivating. I have seen accountants even reducing the number of cups of tea to which an employee was entitled during the day. They will also put an end to advertising activity and expenses, which in their thinking are superfluous expenses having no immediate return.
At the end of this exercise, it may well be that the accounts show an improvement in the magnitude of the loss by sheer cost cutting, however reckless this may be. But in the end, the company is left with a skeleton of a business, without a soul, with underperforming and completely demotivated staff and a portfolio of products which has not been maintained by proper advertising and which is losing market share. In this situation, the management has no alternative than to sacrifice margins and to give more customer credit in an endeavour to “buy sales”. We can imagine the set of new problems to which such measures may give rise, undermining the company’s possibility of going back to cruising speed.
The revenue-driven strategy
We can imagine alternative scenarios based on different strategies, but as long as these stem from theoretical or mathematical reasoning, the end result will remain in the domain of the uncertain. If at the end of the exercise, the result hoped for does not materialise, the business owners will have incurred additional and unproductive expenses which will have worsened their problem. Deep thinking may show a few avenues worth trying.
As a hands-on business driver who has turned around more than 10 sizable loss-making businesses, with a 100% success rate and without ever having destroyed a single job, I will talk about my preferred method, which has proved its worth in different sectors of activity. My strategy is one which is revenue driven rather than cost driven. Generally, a business is loss making when the cost of its structure, namely its personnel, its production and administrative premises, its transport equipment, its bank borrowings and its administrative set up is too high for the turnover, and hence for the gross profit that it generates.
The image of a company creates confidence in customers’ minds to trust the whole gamut of goods that it sells.
When having to improve the bottom line of a company, I lay side by side the financials of the last three years of operation on a spread sheet so that I can get an evolutionary view of the performance over three years as opposed to a static view, for the last year. All the items of expenditure, from year to year, are expressed as a percentage of sales to know which are the expenses that are progressing at a lower rate than the turnover, hence gaining in profitability and which are the expenses that are eating up higher and higher percentages of sales (and hence gross margin), thereby causing loss in productivity.
Essential unlocking of cash
My priority is to look at interest paid because this is the best eye opener. If this charge is too high and on top of this, increasing from year to year when expressed as a percentage of turnover, meaning high and increasing indebtedness, which is a common feature of failing companies, my natural reflex is to look at the following.
- Stock level, with the aim of determining whether the company is over stocked and in which compartment (raw materials or finished goods), and whether there are stocks of obsolete items which have not been disposed of in a timely manner. With this information in mind, I can take necessary steps to dispose of excess and obsolete stocks, albeit at discounted prices and generate cash, to reduce the interest-bearing borrowings.
- The level of debtors and more particularly overdue debts. Debtors may be too high for the level of the company’s activity, and this may also be the result of faulty collection of debtors, doubtful or irrecuperable debts originating from reckless selling with generous credit terms to customers. This analysis will trigger immediate action by an aggressive collection campaign and if necessary, the hiring of professional debt collectors to do a quick job with a view to unlocking cash which can be used to reduce bank borrowings.
- Unproductive assets like idle land and buildings and transport equipment from which spare parts have been cannibalised to be used on other vehicles. Sometimes these are heavy burdens on companies, locking up cash and must be disposed of as quickly as possible to obtain liquidity.
- I also look at the possibility of selling and leasing back productive equipment with a view to unlocking cash. Sometimes it may be advisable to sell assets like land and buildings and continue to operate in rented premises. We must not forget that an ailing business has practically no chance of getting additional bank credit to restructure its activities. The above stripping of assets is essential to unlock cash for more productive purposes.
When the above actions have started to yield their fruits, there is a reduction in financial charges and more importantly cash in reserve (or available borrowing capacity) which will be used to beef up sales, which often requires the injection of cash to support marketing and selling activities. Already the company will be healthier in financial terms, having been oxygenated by fresh cash. Additional interest-free financing can be obtained by a larger recourse to supplier credits if the company’s level of purchase from its suppliers increases. This boils down to a “rapport de force” between buyer and seller, which is a common feature in business.
Beefing up sales
Next, I look at sales. If sales are on a downward trend, it may be due to several factors, for example, difficulty to sell due to low product quality or high prices or insufficient credit facilities to customers. It may also mean that the product portfolio is poor or unbalanced, or not properly maintained by regular advertising. In the short term, sales can be increased by improved, but well monitored credit facilities after the cash unlocking operations mentioned above, and price promotions with a view to selling in larger quantities, albeit at lower margins.
Additionally, a review of the remuneration structure of the sales team may lead to higher performance. As a rule, the most productive way of fixing a sales person’s remuneration is to give a low basic salary and an interesting rate of commission on sales which will make the commission account for a higher percentage of the total remuneration than the basic salary. If the major component of a salesman’s remuneration is variable commission based on sales, it will prompt him to work harder and not have the comfort of having a high and guaranteed basic salary which does not prompt additional effort in selling.
Adding value to the product portfolio
Improving the quality of the product portfolio may take some more time. It may entail the elimination of products having slow rotation combined with low profitability. It may also entail the research of new products having better promises. In my mind, an ideal product portfolio of a sizeable business should consist of three components: (a) fast moving and cash generating items, albeit with low margins, (b) slower moving items with high profitability and (3) optionally one or two lines which give image to the company as a seller of quality goods under nationally or internationally known brands. Very often, the image of a company creates confidence in customers’ minds to trust the whole gamut of goods that it sells. As an example, if a company like Nestle launches a new product, the image of the company will itself help the product to have a head start.
Multi-activity conglomerates often burden themselves with small, accessory businesses which they set up to recuperate all the profit that, in their mind, benefits the service providers to whom they give business, namely advertising agencies, transport companies or fleet management agencies. This syndrome, which has the name of “empire building”, eventually burdens the mother company with a number of satellite businesses which most of the time end up making losses because their staff has no proficiency in running them. Besides this, they do not stand a chance of getting any business from other big companies which one way or the other, happen to be competing with them on certain lines. When a company faces difficulties, such satellite companies must be disposed of, even at a loss, because this will eliminate all the overheads associated with them and will save valuable management time allotted to their running.
Decreasing costs versus increasing revenue
While the accountant’s approach is to downsize the structure and make it cost less, my approach is to squeeze more out of this same structure in terms of productivity to make it produce more revenue. This is a different thinking, and it is geared towards making this same structure work harder to produce 20 or 30% more revenue to be able to absorb more of its cost.
On the cost side, expenses which increase from year to year when expressed as a percentage of sales, reveal a loss in productivity. Ideally, as the activity of a business increases, the percentage of sales going into each item of expenses must decrease, otherwise there are no economies of scale. If it is normal that marketing and selling expenses decrease only marginally when expressed as a percentage of sales, because these expenses are variable and are drivers of sales, administrative expenses must reduce substantially when viewed against increasing sales, because these are generally fixed expenses having no direct relationship with sales.
The option of working on revenue in priority to cost has the advantage of inculcating a winner attitude in staff as they see sales progressing.
The revenue-based strategy relegates to second position the necessity of drastically cutting down costs which affect staff morale and the very activity of the company in the medium term. If revenue is made to increase with the same cost of structure, the cost problem will finally take care of itself, because expenses will eat up a lower percentage of sales and gross profit. Of course, the door to staff redundancy should not be closed definitely, but laying off staff should be a last resort and only activated if there is an imperative necessity to do so.
Cost cutting across the board and laying off staff cause demotivation and take all urge to innovate and work harder out of people.
The option of working on revenue in priority to cost has the advantage of inculcating a winner attitude in staff as they see sales progressing. It also avoids the painful exercise of cutting jobs and creating misery when the need of the hour is better dedication to work and higher productivity in which all helpful hands and brains are needed. It is because of reckless job destruction that company re-engineering has acquired such a bad connotation of being a ruthless exercise. But there are less painful ways of doing this overhauling, which enables smart operators to see light after the tunnel, as explained above.
Essential communication
An essential non-financial measure is to communicate to the staff the exact magnitude of the difficulty and make them take ownership of the problem. Only then we can have a well-knit team working towards one goal with dedication and with the objective of saving their own jobs. Cost cutting across the board and laying off staff cause demotivation and take all urge to innovate and work harder out of people. Working to enhance revenue, and keeping staff aware, at regular intervals, of the progress made, creates a winner attitude in them and an urge to work harder, with brains and dedication because, at the end of the day, they are toiling to salvage their company and to save their jobs.
I have tried this revenue-based strategy of turning around distressed companies over and over again, in different sectors of activity, and it has proved to be the best strategy, which is a forward looking one, an aggressive one as opposed to a defensive one.
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