Turnaround Management – the Income Statement

Dr. Earl R. Smith II
Managing Partner, The Federal Circle
DrSmith@Dr-Smith.com
Dr-Smith.com

In a prior article, I described how management of the balance sheet is important in efforts to turn a company around. In this one, I would like to mention a few issues that affect the income statement and describe managing them will advance any turnaround efforts. An income statement is in two parts – the revenues and the expenses – and both need to be carefully analyzed. Remember that the overriding objective of any turnaround program is to put the company back on a solid footing and on the road to health and profitability. Any progress – by either increasing the net value of revenues or controlling expenses – will help a turnaround manager to reach that objective.

Revenues

A typical mistake that many executives make is to reduce the analysis of the revenue side of the income statement to ‘well, we need to generate more revenue’. This approach very often causes missed opportunities to improve results. Most companies have a diverse range of products and services and each one needs to be looked at carefully. Here are two examples from my own experience which will show you what I mean.

I was engaged to help company ‘A’ recover from a disastrous couple of years. Management had made a series of very bad decisions regarding its product-service mix – including one which had committed the company to a 24/7 obligation. I forced a detailed review of the revenues of the company – and the review showed that the service was actually costing much more than the revenue it brought in – the margins were negative!

Company ‘B’ had a mix of services and products – very often an indicator that there are problems. As a result, the company had to maintain two different sales forces – one for direct sales of the services and another through a network of resellers for the products. The results were overhead burdens and high turnover in both areas. Every revenue line needs to be carefully analyzed and the fully loaded margins need to be calculated. Many companies that I have worked with have never done this. Their revenue stream is a sometimes-chaotic mix of what was intended and what became available.

One particular company I worked with had developed a source of revenue which was well beyond the core skill sets of its employees – causing a tensions and inefficiencies.

Expenses

As chaotic as the revenue side of the income statement can be, the expense side for distressed companies can be even more so. Problems generally arise from four areas – costly acquisition arrangements, overloading with unproductive consulting agreements, inappropriate compensation schemes and a very expensive capital structure.

Acquisition of resources includes both materials and human resources – and both can be a real problem. I have discovered materials acquisition arrangements, which almost assured that a company was paying top dollar. Many times substantial improvements are realized by simply renegotiating these agreements or seeking out other sources. Often management will respond to a downturn by bringing on a series of consultants to do what management has been unable to. Many times these agreements reflect the pressure on the company and totally lack any effective performance metrics. An independent, third-party review by a turn-around specialist is often the best way to conduct either a renegotiation or termination of some or all of these agreements. In some engagements I have found the need to take part of the savings and invest in an expansion of the senior team – to bring onboard necessary skill sets.

Compensation packages – particularly for senior executives – can be a very sensitive subject – even in distressed situation. But the issue has to be addressed and adjustments made. In some situations, I have discovered that an inordinate percentage of a company’s financial resources had been going to a senior team which was under-performing.

Often this situation arises because of an ineffective board of directors – or one controlled by senior management. Lacking any effective oversight, executives are not forced to connect their compensation to the results they achieve.

Finally, I have encountered companies which would normally be profitable if it were not for their over engineered or highly expensive capital structure. One of the most common are companies which have managed to go public with very limited run rates. Most of these are NASDAQ bulletin board companies that really have no business being public – are burdened with the cost and exposure of being public – and got that way through an ill-conceived idea that being public was the way to go. One company had gross annual revenues of less than one million dollars – and was disintegrating under the pressure of being public. There are other reasons why a costly capital structure can doom a company. Another company had debt financed its expansion and faced rising costs as the lenders increased interest rates to reflect the distressed condition of the company. A third company had a board dominated by investors with very short-term perspectives. They were driving the company to ‘dress itself up for sale’. A professional turn-around effort begins with a careful review of the income statement. Done well – and acted upon – such a review can go a long way to returning a company to health – and putting it back on the road to profitability.

© Dr. Earl R. Smith II

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Related Articles:

• Moving the Ball

• Turnaround Engagement – Part II

• Turnaround Engagement – Part I

• Turnaround Management – Cash Flow

• Turnaround Management – Initial Steps

• Turnaround Management – the Balance Sheet

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