Oct 202014

Dr. Earl R. Smith II

A good turnaround plan attacks problems on several fronts at once. It also recognizes that some issues need to be resolved prior to moving on to others. One of the first places that any turnaround effort should focus is on the company’s balance sheet. Many companies, which find themselves in difficulty, have evolved balance sheets that are ‘upside down’. By that, I mean a growth in liabilities and a reduction in assets.

The big problem with such a balance sheet is that it both negatively brands the company and can severely limit its options. Investors will go through the balance sheet before they move on to a more detailed financial analysis.[1] This financial statement, more than any other, will give the reviewer a glimpse into the financial wellbeing of the company and a reference on the competency of its management.

When I review a balance sheet, I look for imbalances – places where things have gotten unbalanced. I also look for opportunities to improve the condition of the company by addressing some of the imbalances. The two most likely are the accounts receivable and payable. If the company has a relatively simple set of receivables and payables, I might decide to attempt to manage them directly. However, if the situation is at all complex I generally decide to bring in professionals. By professionals, I do not mean a collection agency but an organization that specializes in management of both receivables and payables.

It is, of course, in the company’s best interest to collect as much of the outstanding receivables as possible. When it comes to payables, the matter is a bit more complex. On the one hand, a company would want to settle the accounts for the minimum. However, and here is where the complexity tends to come in, some creditors are more important to the continued existence of the company than others are. In addition, the security of some creditors will be much more solid than that of others. Complex situations like this require experienced professionals. The situation needs to be resolved in a way that improves the company’s odds of surviving, maintains critical relationships and settles the payables without recourse to either legal action or bankruptcy.

An example of a company, which I would bring into these situations, is Metro Capital. Metro’s Balance Sheet Surgery focuses on improving a company’s position by managing both its receivables and payables. Metro has the experience, expertise, and resources to resolve a company’s difficulties while avoiding a bankruptcy filing. They evaluate a client’s balance sheet, capitalization table, profit and loss statement and cash flow forecasts. With this information, they can both structure and implement a plan that works for all stakeholders. This approach allows Metro to resolve difficult situations involving multiple creditors and significant money. Metro Capital regularly achieves favorable results in complex situations.

Any turnaround specialist must know what they are capable of and what they need to outsource. CEOs and Chairmen need to tap into the same wisdom. Balance sheet management tends to be one of those areas – particularly when it comes to managing receivables and payables. To try to take these issues on without professional help is to risk having things degenerate into a real mess – particularly when the situation involves multiple creditors with conflicting legal positions. The presence of an experienced, independent third party in the process can often make resolutions possible that are otherwise unattainable. I have seen companies try to manage the righting of the balance sheet on their own and some of the experiences have not been pretty at all. A friend describes the situation in terms of a to-do list:

  • Enter marathon
  • Pay entry fee
  • Get revolver
  • Load same
  • Shoot self in foot
  • Run marathon

Management which enters these rather dangerous waters without professional help are risking a similar fate – particularly since most professionals in this field work on a purely contingent basis.

The objective of Balance Sheet Surgery is to increase the company’s cash position by collecting receivables and negotiating favorable settlements on payables. Correctly done, it can both improve prospects for the company and improve the reputation of the senior management team.

© Dr. Earl R. Smith II

[1] During my time on Wall Street, I learned that the proper way to read a balance sheet was from the back forward. You start with the footnotes and, only after clearly understanding them, move to the statement itself. Many times a review of the footnotes will make reading the balance sheet itself unnecessary.

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