Step 3 In Avoiding Bankruptcy - Develop A 30% Downside Contingency Plan
I have been preaching contingency planning for the past 25 years and it frustrates me that owners and executives consistently believe it is unnecessary. Now, of course, everyone is listening but they miss the main point – contingency planning must be performed when the environment is not stressful to enable clear thinking.
Contingency planning cannot be done internally for the obvious reason that some executives will view it as a signal that they may be terminated if revenue declines significantly. As a result, the contingency plan never gets developed. When an actual crisis does occur, critical time is needlessly wasted on designing the plan rather than implementing it.
Revisualization – Current State VS. Future State
When developing a contingency plan, the tendency is to establish the current state of the business and use this as the starting point to reduce costs. That is the wrong way to develop the future state – if you take this approach you will never get there.
The KGI System™ recognizes the challenge is to re-visualize the business. If sales were in fact down 30% how would you organize such a business? What did your business look like when it was growing and sales were 30% less than the peak? Were you profitable at that time? Then you can be profitable again. Often it will require:
- A consolidation of management
- A consolidation of facilities
- Reduction in the number of SKU's / services
- Changes to the compensation system
- Restructuring the organization
- Having a secured and unsecured creditor plan to generate cash flow
- Outsourcing some in-house activities to maximize flexibility
If you are to get through the crisis you cannot run out of cash and you cannot depend on the existing or outside sources to provide additional funding. When the economy is in trouble, sources of capital dry-up. I suggest that clients develop contingency plans at multiple levels from 20% to up to 50% in some cases.
The exercise will be useful because it will produce unanticipated benefits. What are they? My experience has found that by developing a contingency plan, management often realizes meaningful cost reductions that can be implemented immediately. For example, the plan may show that if revenues were to decrease by 30% the company could consolidate an administrative function from numerous regional locations to company headquarters and reduce costs. If so, why wait for the climate to worsen – why not implement and reap the benefit now?
It's The Balance Sheet
That strange document, the Balance Sheet, rests behind all the profit and loss information that most executives use exclusively to manage the business. It is the key to not running out of cash when business slows down. Your Balance Sheet not only tells you how much you can afford to grow but it also tells you how low you can go before you run out of cash.
Generally, recessions last more than three years and businesses must have the staying power to survive during the period. If you have planned well and are in a strong cash position, recessions become an opportunity to buy competitors at deep discounts. However, if you are over-leveraged with a high debt-to-equity ratio, it is more likely that you will be acquired at a deep discount.
Low interest rates have lulled executives into thinking that they can use short-term borrowing to fund capital expenditures and other long term objectives. It doesn't work and you typically find yourself trapped. While leverage makes profits look better during market expansions you get into trouble faster when the market turns.
Why Must Contingency Planning Be Done By Outsiders?
Executives are not about to recommend their own demise and are also reluctant to recommend the termination of their fellow executives. They will often enter into unofficial agreements not to touch each others turf and instead terminate the less expensive people that report to them. This is human nature. It is a bad idea to let executives know they may be on the block when times get tough and it also establishes an informal hierarchy of where they stand relative to the other executives.
The plan should be performed privately with only the owner and a professional CEO involved and kept confidential until it is time to unveil. This conflict between contingency planning and the executives' welfare is the most common reason that the plans are neither comprehensive nor complete. The failure to fully develop a 30% downside contingency plan can lead the company to disastrous results. A qualified professional will not only develop a workable viability plan at different levels of revenue, but will have the objectivity to identify areas for cost reduction and operational improvement.
Whether a Company is struggling financially or on the cusp of breakthrough growth, KGI can help. Our seasoned experts work alongside management to solve complex cash flow issues, operational challenges and other business crises. If liquidity or sale is needed, KGI provides a powerful combination of services and expertise to achieve outcomes that cannot be duplicated by other standalone consulting firms.