Why Cash is King in a Tight Economy
Helen Mallovy Hicks
Calum Semple, a lead partner in the Restructuring and Distress Strategy Group at PwC, helps us understand ways companies may be able to improve their cash line and liquidity during the downturn.
Dean: Welcome to Strategy Talks with Dean and Helen, part of the PricewaterhouseCoopers Managing in a Downturn podcast series. I'm Dean Mullett, co-head of our Restructuring and Distress Strategy Group, and a member of our Credit Crisis Task Force.
Helen: And I'm Helen Mallovy Hicks, a Partner in the Advisory Practice of PricewaterhouseCoopers in the Dispute Analysis & Valuations group.
Dean: The current state of the economy is understandably of great concern for most Canadian businesses. This series of audio podcast discussions with a variety of subject matter and industry guests are designed to help your business weather the storm by exploring some of today's hottest issues related to the economic crisis. Welcome to PwC's Strategy Talks. In today's episode, "Why Cash is King in a Tight Economy", we are joined by Calum Semple, co-head of our Restructuring Distress Strategy Group here at PwC. He'll help us to understand some ways companies may be able to improve their cash line and liquidity struggles during the downturn.
Calum: Good Morning.
Helen: Calum is co-leader of PwC's Restructuring and Distress Strategy Group, you would no doubt agree with the adage that 'Cash is King', especially in this economy, but I'm sure there are more companies struggling with liquidity issues right now than ever before. Will companies find new ways to manage their cash and working capital?
Calum: I think it's the case that companies have to find new ways to manage their cash and working capital. You have no idea how many times we hear from companies that our business plan shows us with a profitable month-by-month P&L so don't worry about it. They don't even worry about cash. It's really quite amazing.
Helen: That is astounding. So what are you doing now to change that?
Calum: Many companies are still in denial and unfortunately many times that we're brought in it's by a different stakeholder in the game other than management or ownership. And many times it's by lenders. Sometimes the board brings us in. But we are starting to see cracks appearing where company owners, or company management are starting to realize that maybe something's not right, and if they start doing something now to sort themselves out, that they can live through the next few years.
Dean: Not having enough access to liquid assets can have a negative impact on the company's performance both short-term and long-term. What are some ways companies can quickly improve their operations to deal with these challenges?
Calum: I think you just have to go back to the basics and start looking at the key building blocks for working capital. If you start off with cash, first of all you don't need to spend as much cash probably now as you would have historically, so you can start looking at simple things like discretionary spend, which I would call more cost avoidance. Companies typically look at cost avoidance maybe first they don't look terribly deep but they'll certainly look at things like SG&A spend, travel, the basics like that. They then also start to look at cost reduction and this is where life gets interesting, because cost reduction is not always in the short-term the right answer, and I'll give you an example of that. I have too many people in my headcount. I let twenty percent of my workforce go. Unfortunately along with that, I may have pension make-ups to pay into funds, I may also then have to pay severance. How am I going to do that?
So actually approaching workforce reductions in a more creative manner can sometimes work, and by that you can do things like putting things on rotating shifts, four day weeks, and we're starting to see some companies thinking like that. The other elements of working capital - things like how I pay my customers…some people have traditionally paid ahead on customers to get discounts. Maybe that's the right answer, and maybe it's not - but they don't really understand the mechanics of what's right and what isn't, and why they're doing it. On the supply base, you have the luxury, in some cases, of being able to use your suppliers almost as extended bankers. But again you have to be careful in that you understand the limits of what you're doing and the impact on your long-term strategy of doing things like this.
Dean: If you're looking at ways to cut costs and save some cash. You mentioned suppliers, so suppliers come at you in a whole bunch of different ways, but a lot of businesses have long-term supply agreements. Do you think this is a time to maybe reopen some of those supply contracts?
Calum: I honestly believe that virtually every supply contract that's written today is up for negotiation. In some industries, such as automotive for example, it's been pretty much an un-written rule or a rumor out there that the contract isn't worth the paper it's written on, and in many cases, unfortunately, that's proved to be true. But I really think that it behooves every company management to go back and look at supplier long-term agreements. We've seen disagreements if you go back over the last few years, for example, the steel industry where people had signed up for pricing that the suppliers frankly couldn't live up to, and there's an example of actually having to give your suppliers potentially pricing increases, just to keep them in business. So there's a push and a pull in this. It works on both sides.
There's no point in driving huge cost reductions into your supply base if you're going to drive your suppliers out of business. You can look at the oil patch at the moment, the pricing for the majority of the large contracts that are for the big construction projects, were negotiated at the peak of the market. Virtually all the big oil companies now are trying to re-open those agreements and go back to contracts and say, "Look, you're not busy this year. The price of materials has gone down. Why should we pay you at the peak of the market pricing?" So, we still want to keep you in business. We still want you to do the work, but, we'd also like something a bit more realistic in pricing. And the reality is if they don't, they're looking at all kinds of cancellation clauses, and then going elsewhere. But if you do that, then you just throw chaos into the mix and that's really not the right answer for everybody either.
Helen: Calum, are you finding that companies are mainly being reactive in this situation, or are you finding that they are getting more strategic? And how are you helping companies be more strategic in managing their cash and liquidity needs?
Calum: I think the majority of companies today are still being reactive. The really well managed companies are not. But then the really well managed companies, the ones that you would expect (some are public, some are private), and they've just historically always done the right thing, and they'll continue to do that. The number of companies that fall into that category, unfortunately, is fairly small. And then they progress throughout the chain, if you like, from being really well managed, to really not even thinking about cash.
When it comes to being strategic, those are the kind of things where I think there's a huge benefit in having third parties come in who are neutral and not emotionally attached to anything. That would just tell you the way it is. Management, in many cases, has limited capability to build the kind of models that they need, to really understand the different scenarios and the sensitivities within their total system. This is not something where you want to just do a simple model and look at, for example, inventory in pure isolation. That won't solve your problem, because you may do something that fixes one problem, and causes you an even larger one somewhere else in your organization, at which point, you maybe don't have a company anymore.
Helen: What about companies today that need to find ways of driving short-term improvements to their cash line. What advice can you give those companies — advice that helps them both in the short-term and the long-term?
Calum: I think in the short-term, most companies will say that they've looked under every stone and they really can't save anymore. That's typically if I look at the companies that we go into that are really about to fall off a cliff, or frankly have fallen off a cliff, and we've been brought in by a lender or some other stakeholder. It's interesting, but we can nearly always find a lot more. Because again, we're asking much harder questions than management are prepared to ask themselves. This isn't about saving yourself or frankly saving a whole bunch of people, or protecting these customers because they've always been good customers. In many cases, downsizing can actually be the savior in the company. Management is always really, really reluctant to go down that path.
Dean: A few minutes ago, you talked a bit about the oil and gas industry, and I think we've seen it in the headlines, the number of the expansions and CAPEX programs that have been put on hold or cancelled. What's your view on reviewing projects in flight, and maybe looking to your CAPEX line to shore up short-term cash?
Calum: It's always a risk because if you take…and again it depends to some degree where you're funding your CAPEX from. If you're funding your CAPEX through a third-party lender, they're probably not going to be very happy with you redirecting your operating line. So you'd want to think long and hard about that one or you're going to create a whole bunch of different problems. I think if you are funding CAPEX internally from your cashline, then you are probably a fairly healthy company in the first place. There's no harm in redirecting it and the questions you have to ask yourself is, once we're over this hurdle, you know for example in oil and gas, if oil pricing goes way back up again, which many project it will…I've seen projections of sixty, eighty dollars by the end of this year. All of a sudden, the train will stop moving again. You don't want to put yourself in the position where you've spent even twenty percent of your CAPEX budget on something else, and then all of a sudden you've got to go back out to third-party lenders to try and fill the gap, because it may be difficult.
Dean: And I guess in looking at commodities in urban sector - oil and gas, mining, and things of that nature, one thing has often been repeated to me is that we save cash today at the cost of the future. So when the commodities pick up down the road, we just don't have the supply at that point in time, which, in itself creates a problem.
Calum: That's exactly the point, I mean, that's an industry that you really do have to stay very focused on the medium and longer term goals and objectives. And rather than re-directing CAPEX, if it's come from an internal source to your cashline, maybe the answer is just look at how you can scale back the demands on your cashline today, so you don't have to shore it up as much. It's an industry in some ways it's set up so it has a huge variable component of it. If you look at the way that they outsource, it's huge amounts of labour, contracts, those types of things. They have the ability to wind those down. The question that they have to ask themselves, and having spoken to a number of them now, they're starting to look at it, some more so than others. When you wind down the demands on some of your suppliers, you do want to make sure some of those suppliers and venders are still there when you come back to them in a year. And that they didn't get wound down so much by so many customers that they're not around. And then when you come back to ramp up your project again, all of a sudden the number of vendors available are fewer and far between.
And guess what? The price actually went up, because the demands on those venders increased. It's a real balance for sure. Too many companies probably get hung up too much on the long-term strategy at the cost of short-term, but at the same time, and this can happen sometimes frankly when you bring in third party advisors, they get too focused on the short-term, and just completely ignore the medium and long-term. It's a real fine line and a balance, and you really have to consider everything by company, by sector, by individual situation to come up with the right answer.
Dean: You know, one of the things that I've seen in working with troubled and challenged companies over the years, is, often times you'll have a company that has multiple divisions. Some will be good core businesses and some, perhaps will not be core, and may not be performing. What are your views on companies taking a look at various lines of business and perhaps exiting, and how they would go about exiting some of those businesses that aren't performing?
Calum: I think historically, and 'historically' in terms of these days, is an interesting term in itself. Historically probably means nine months ago, versus where we are today. But the reality is yes, you can have non-core, non-performing or less, optimally performing assets, is just the way I would put it. So we have seen some clients looking at other alternatives to exiting. Unfortunately for the local market, we've seen a number, and we continue to see a number, of foreign-owned manufacturing companies exit Canadian-owned subsidiaries.
And some have actually tried to sell, they've had their subsidiaries on the market for the last two years, in some cases they haven't been able to complete a sale process, so they're winding them down. And they go through a combination of voluntary liquidations, manage wind downs, some will go through a CCAA type process to try and maximize their own gains out of the exit, or minimize their losses. But that really depends on - well the process followed, really depends on the company itself, and how it puts it in order of priority, keeping customers happy that may be global, looking after global local management and work force that's been have been loyal to them for a number of years, keeping local trades and suppliers whole, and then looking after local lenders if they have third-party debt.
Dean: It certainly sounds like it could be pretty complex and given if it's a foreign company overseas somewhere, and leading that to the management team locally, I guess you might have some competing agendas.
Calum: You always do in any kind of distress situation. It's almost impossible for management to approach any decision without saying 'how does this impact me'. And that's management at all different levels. Now, we talked about supply chain earlier on, which has exactly the same set of questions that a local supplier, manager or procurement manager would ask themselves. If I do something that involves outsourcing this piece of work, or I resource from this supplier to another one, how does it impact me. Is it more work for me, is it less work for me, is there a potential here that actually some of my department isn't going to have any work going forward. It's very difficult for people to make un-conflicted decisions these days.
Helen: Calum, you talked earlier about companies thinking they've looked under every stone to find that cost cutting opportunity or additional amounts of cash flow, but always when you come in you can find something different. Why is it that management, who should know their business, isn't finding these opportunities and can you maybe tell us some more stories, some of the things that you've been able to find and help clients turn around their operational situation.
Calum: Management's buried in a company day-to-day, they live and breathe their company, their sector. In many cases you'll see management that's only ever been at the company they're at today — they've been in various positions and progressed through, or they've only ever been in the industry sector that they're in today, so they're very familiar with the way the industry works, and they're very familiar with the way their company works. Which can be good and it can be bad. Even in good times, frankly, one of the things that we discuss with companies many times is that they're constricting their own growth and success. Putting a positive spin on all of this, they'll say 'well we're already making money. Our EBIDA is whatever it is — ten percent, fifteen percent. That's great, so if we benchmark ourselves against the industry we're in, we're doing well.' Why benchmark yourselves against the industry? Why limit yourself to that?
And I think when you're looking at cost reductions, it's exactly the same scenario, but on the other side of the red line as it were. They will regularly look at headcount reductions, but they'll always ask, for example, their production folks, for whatever headcount reductions they think they can accommodate. Conversely, management may just sit in their C-suite and say we're going to cut head count across the board at twenty percent. Could it be twenty-five percent? Could it be thirty? Does twenty percent actually jeopardize the company's on-going operations to the extent that that's a false economy? They don't think beyond their own little world. Back to an adage on a material manager. If we take a requirement to reduce cost in a supply base - and we saw a perfect example of this last week. Our material manager was well aware that unbeknownst to his central corporate procurement people, that the cost reduction that they had just forced out onto our supplier was jeopardizing that supplier. So the company was saving from a P&L perspective, and an ongoing cash flow perspective, but delayed by 60 days because of payments, ten percent on this given supplier.
It actually had a negative impact on the working capital because that local material manager went out and ordered 15 more truckloads of materials than he actually needed, and filled the warehouse up - he was protecting ongoing production. And we see that over and over again and if you go back and look at some of the stats of whether it's sales, or gross margin, inventory, as they relate to companies dealing with issues. In many cases, if it's supply chain related, inventory will go up, because people like that are doing it on a very local basis: something that makes sense to them, but not to anybody else.
Dean: Well Calum, we're almost out of time. With our remaining moments, if there's one piece of advice you could leave our audience with, what would it be?
Calum: Don't think that the plan that you have today is the one you have to live with going forward. Really look hard at, and question, all of the decisions and data that's in front of you today, and if need be, go back and ask someone that's not involved in your business day-to-day, to give you their opinion on what you've decided and what you've planned, because they'll often give you a different answer.
Dean: Thank you very much.
Helen: One last question. Dean and I have been giving all our interviewees at Strategy Talks the opportunity to give us their elevator speech why our clients and our listeners should be hiring you to help them with their strategy and restructuring needs.
Calum: I think our approach at PwC to turn around and restructuring is very holistic and is very different to many of the examples you'll see in the marketplace. If I was to sum it up, we have a turn-around group that's very focused on the day-to-day operations of an organization, bringing in industry expertise and looking all the way through the organization from sales, the way that they deal with customers, the whole cost structure, how supply chain works, and how that relates to the whole systems in reporting finance to the company itself. Once we've determined what the optimum operating conditions for a company are, we then will determine what kind of balance sheet we need to support that.
From a balance sheet perspective, our restructuring group is extremely good at taking the existing balance sheet that a company has today, and creating a series of steps to get to the right answer. And that could include everything from the traditional re-negotiate covenants with lenders, sale of assets which again links back into the operational side of the business that says, "What do we have to change to allow those assets to go?" And then from a corporate finance perspective, we have the true capabilities to go out and raise additional capital or replace existing facilities as needed, and then also to sell those assets if needed in the most effective manor. So if you like, it's a continuum that we can really start at any point on, and deliver something that I think is quite industry specific and something different to most customers.
Dean: Thank you, Calum for your simple, honest and practical advice. Please come back and visit us again here, on Strategy Talks.
Voice over: In the next episode of Strategy Talks, The Recessions' Impact on the Accounting World, Helen and Dean talk to Mike Walke, a Partner with PwC and Audit and Assurance Credit Crisis Leader. Mike explores some of the key challenges to financial reporting in troubled times, and how to better manage these. Here is a sneak preview of what Mike has to say.
Mike: How are they dealing with working capital deficiencies? How are they dealing with future cash requirements, whether it be pensions, commitments on fixed assets, forward agreements where they may have to fund collateral? All of these issues can have a huge impact on the financial statements.
Dean: This concludes this episode of Strategy Talks, part of the PricewaterhouseCoopers Managing in a Downturn podcast series. I'm Dean Mullett, thank you for listening.
Helen: And I'm Helen Mallovy Hicks. We hope you'll join us again soon for another episode. To download or to subscribe to this podcast series or to find more information on this topic, please visit our Managing in a Downturn website at pwc.com/ca/managinginadownturn.
The information in this podcast is provided with the understanding that the authors and publishes are not herein engaged in rendering legal accounting, tax or other professional advice or services. The audience should discuss with professional advisors how the information may apply to their specific situation. Copyright 2009, PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or as the context requires, the PricewaterhouseCoopers global network or other member firms of the network. Each of which is a separate and independent legal entity.