First, there is no hard rule or definition as to what constitutes a corporate turnaround or a corporate restructuring. The generic term is a company or firm or business unit that exhibits financial performance that in the foreseeable future, unless short-term corrective action is not taken, may fail. Let us say:
A corporate restructuring or turnaround may be simply defined as a company’s existence is threatened as it moves from economic performance to decline or zone of insolvency. The decline or bankruptcy may take several years, however when extreme events take place, a shorter time frame may put the enterprise into peril.
In some circumstances the term may mean a financial restructuring by reorganizing and/or cleaning up the balance sheet using financing methods that changes the capital structure of the organization.
Surprisingly, a turnaround can be a situation where a company may exist without having a cash crisis. When measuring a company’s performance, as measured by return on capital employed, the turnaround candidate can be an organization that is performing below what is expected for a business in which it is engaged. It is about recognizing that a company often displays symptoms of failure prior to any crisis beginning. It could be businesses with underutilized assets and poor management. Many companies have survived or stagnated for years in spite of ineffective management. If such stagnation does not change, the crisis situation will succeed because management has not taken the necessary steps to turn the situation.
Crisis situations are often in stable and mature industries and sometime with competitive advantages. Such companies are also firms that are closely held or family controlled. To avoid placing the enterprise in a crisis, it is about early instituting turnaround and restructuring strategies to avoid company trauma. Too often even a growth-oriented company that has grown too fast and is very profitable may experience a severe cash crisis. Alternatively, a company can report a loss in one year does not constitute a turnaround issue. Such a loss may be expected in executing a competitive strategy. However, a loss in one operating unit may place the whole company into a death spiral.
A company can become insolvent if management takes no corrective actions. Even external events may postpone the inevitability on insolvency, but it will not avert it. The outcome of management’s corrective action either will be successful or unsuccessful in which case the insolvency will lead the company into bankruptcy.
Generally, a corporation’s life cycle can be looked at as a humped curve of four stages. From (stage-1) start-up the company grows to a point of (stage-2) maturity then begins to (stage-3) decline until it reaches (stage-4) the “zone of insolvency“. Not all businesses follow such life-cycle curve, since organizations can be reborn or transformed anytime. Some companies, in fact, institute competitive strategies that change the shape of the curve to an S-Curve to progression. The corporate turnarounds logically addresses two issues:
Defining turnarounds on the basis of profitability (return of assets or return on investment) alone is problematic. The accrual quality of the turnaround company’s accounting may be low and result in manipulated earnings management. Companies gradually lose competitiveness, but this is often not reflected in deterioration in profitability. Rather, earnings flat line then plummet or the time lag between competitiveness and earnings improvement exist. With management’s “window dressing” a lag in indices showing a distressed state, the signals of impending trouble can be masked.
Simply put, the framework of the turnaround is to avoid the company moving into the “zone of insolvency” and then ultimately into bankruptcy. Taking proactive strategies to control the business is the objective.
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