Inside the mind of the downturn director

All over the country, directors of small to medium sized enterprises are looking out for red flags – warning signs that their companies might be in trouble.

With personal assets and reputations on the line, they now face the risk of trading while insolvent.

It wasn’t always like this. About 18 months ago, they were focusing on growth. But with so much uncertainty now about the future, their attention should be on just two items – cash and receivables.

They take precedence over all other issues; like for example, managing the sales pipeline. And those are the two items behind the questions directors need to ask in the board room.

If you are an entrepreneur with a board of directors or advisers, there is a long list of questions you should get ready to answer:

• How much cash is coming in?
• What’s the maturity of the receivables?
• Are companies now taking longer to pay their accounts?
• How has the business environment affected the terms of trade? <
• Has 60 days become 72?
• Or has it blown out to 90?
• And what does that mean?
• Are clients and customers managing their cashflow smarter and harder, or are they in trouble?
• Which creditor accounts are not being paid on time?
• Are there new demands from creditors?
• Can the company make superannuation payments on time?
• What about repayment agreements with the tax office and other agencies?

At the same time, however, directors should keep an eye on potential opportunities. Good directors and managers should never waste a crisis, even if that means changing your business model.

Simon Theobald, a partner with recovery specialists PPB, says directors of SMEs should watch out for signs of insolvent trading. That, he says, is their biggest risk in this climate.

“Where there are reasonable grounds for a director to suspect that a company which they are a director of is insolvent and that company continues to trade, then the directors are potentially liable for those debts incurred,” Theobald says. “It’s not something that director indemnity insurance will respond to.

“Obviously their personal assets are on the line, and there are potential criminal ramifications too if it’s a matter ASIC wants to pursue.

“It’s important for directors to have a good understanding of their company’s current and projected financial position,” he says. “Directors need to be vigilant about identifying threats to the trading performance, and therefore the financial position of their company.”

Another good indicator, Theobald says, is the size of company’s overdraft. “Overdrafts and facilities such as that are handy, but an overdraft should be a cyclical and fluctuating facility. When its limits are becoming what’s known as ‘hard core’, when it stays at the limit for a reasonable length of time, that’s an indicator that you probably don’t have enough working capital.”Charles Macek, a director at Telstra and Wesfarmers, says there is a good reason why the focus needs to be on cash. “Companies go broke primarily because they run out of cash, not necessarily because they are bad businesses,” he says. “If you run out of cash, then you are out of business.”

Macek says directors are, by nature, a conservative lot. But in this tough climate, they are likely to become even more so. It might even force them to make the hard call, pull the pin and put their companies into receivership.

“When you have a very substantial liability personally, you are going to be by nature conservative, and in Australia we have a very tough going-concern regime and continuous disclosure regime,” he says, “and therefore at the margin it might push companies in Australia in this sort of environment to a point where directors would say: ‘We are not going to take the risk for potentially being seen as putting ourselves in a position where we are seen as trading while insolvent and we’ll call in an administrator’.’Macek believes directors are now putting in more hours. That’s partly because of the increasing regulation (with more to come as the market gets tougher) and partly because of the economic downturn.

“When times are good, you are getting good numbers all the time, and everyone is happy and there is not that much pressure on you to drill deeper. When business is tough and the numbers being presented are not that good, what you are trying to evaluate is how well management is coping, and you have to drill a bit deeper.”

Graeme Bowker, a director of several SMEs such as the New Zealand-listed Tourism Holdings, the company behind Britz campervans and Maui motor homes, agrees that directors are working harder than they were six months ago.

He says directors now need to spend more time questioning the assumptions that served the company well in the past. It’s a different world now, and Bowker says what worked two years ago might no longer serve its purpose.

“The environment has changed and you would have a lot more sensitivity to the assumptions you are using, and challenging those assumptions and cross checking and verifying them,” he says.

“With one company which I was involved with, we were certainly every week looking out for 13 months as to how we might survive. You are constantly on the telephone. But I would argue we were doing our job,” he says. “Is it the most pleasant thing? No. And it can be depressing, but the directors I have worked with have kept their minds on the task and got in and did the hard work.”

What do executives need to do to keep directors happy? Give them quality information, and make sure there are no surprises.

“If management is giving you quality information and engaging in the right quality debate, then I think the chances of you finding the solutions are higher. The ask is higher. Boards quite rightly are being more demanding about the quality of the information.”

But Bowker says questions also needed to be asked about potential opportunities. One of his companies, Bluestone, for example was in the business of originating mortgages. When the securitisation market blew up, it saw the chance to make money another way; servicing mortgages.

“Change creates opportunity,” Bowker says. “How do we get our minds around that and how do we, as directors, work with management to get the best out of what that opportunity might be? While survival is important, there are opportunities.

“I think you can be a little bit more positive, and therefore survive through those opportunities.”

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