Leading with impact: How board members can steer their companies through financial and operational distress situations

By Augustina Ekua MILLS, Gideon BOSOMPIM & Esther ADDEI

In recent years, the global economy has been hit hard by multiple crises, such as the COVID-19 pandemic and geopolitical tensions. These events have increased financial risks and slowed down growth, affecting businesses worldwide, especially in developing countries such as Ghana.

It is therefore important for directors to understand that any business can face financial and operational challenges due to changing economic conditions, shifting consumer preferences, new regulations, or technological advancements.

Good corporate governance means that directors need to provide strategic oversight, ensure the company remains profitable, and act responsibly towards all stakeholders. In today’s world, characterised by volatility, uncertainty, complexity, and ambiguity (VUCA), directors must be adaptable, flexible, and resilient. Spotting early signs of trouble is crucial, so directors can take a strategic approach to manage risks.

Since directors are not involved in the daily operations, they need to identify distress signals by analysing management reports, assessing liquidity, and monitoring key performance indicators. Working closely with management is essential to stabilise the company’s financial health before problems escalate.

During tough times, directors might need to explore both formal and informal restructuring options. Experienced advisors can be invaluable in assisting directors navigate these challenges and steer their companies through difficult periods.

The global economy in the last few years has experienced one crisis after another due to the COVID-19 pandemic as well as geopolitical and social tensions. The International Monetary Fund (IMF) and the World Bank have defined this as a poly crisis[1].

In the last few years, inflation in many countries including Ghana are at higher than benchmark levels and this has heightened macro-financial risks and slowed growth. The ripple effect on businesses, especially those in developing economies cannot be over-emphasized. It is therefore imperative for directors to understand that any business could face financial and operational distress at some point.

Financial distress could be driven by adverse economic conditions, evolving consumer preferences, regulatory changes or increasing costs of production. Also, operational distress could be driven by complex processes, advancements in technology and unskilled staff. Directors and management teams should be adequately prepared to manage situations that could result in financial and operational distress. Depending on the cause, it can be a slippery slope down the demise curve from underperformance to crisis.

Identifying the early warning signs of distress (both financial and operational) can be a challenge for directors, given that they do not manage the day-to-day operations of the company. However, the importance of the role of directors in taking a strategic view, to developing a plan, to managing both financial and operational risks cannot be gainsaid.

The importance of Board of Directors in Corporate Governance

The board of directors’ role includes providing strategic oversight over the activities performed by a business’ executive. Directors work to ensure the business remains profitable while acting responsibly towards the welfare of its shareholders and stakeholders.[2]

It is therefore imperative for directors to recognise that every company can at some point face financial and operational pressures given the constant, unpredictable changes that are now the norm in certain industries and areas of the business world. In the light of volatility, uncertainty, complexity and ambiguity (VUCA), directors are required to be adaptable, flexible, and resilient. [3]

For directors to fulfill their fiduciary responsibilities, they need to be able to recognise and address potential stress factors as they arise. While key management personnel gain a deeper understanding from managing the day-to-day operations and can spot signs of distress relatively early, there is often an issue of information asymmetry within the business that may prevent directors from detecting these warning signs.

Therefore, directors need to put in place mechanisms to ensure that conversations on financial and operational resilience are included in discussions with management. Further, as part of the board’s oversight of risk management, information on potential idiosyncratic and systemic stress factors that may impact the business and available options for recovery should be analysed. The pertinent questions which may remain unanswered by many board members are.

• How can directors identify when a company is showing signals of distress?
• What happens if key management personnel are unwilling to raise certain issues with the board or admit that their business may be struggling?

Identifying stress signals

Prompt identification of signs of distress helps directors and management to have more value preservation options.[4]  Early warning signs are not always obvious as some challenges may appear to be one off. However, mechanisms for identifying early warning signals gives directors and key management the opportunity to refocus the business strategy to stabilise operations.

How can boards practically identify signals of distress, especially when they are not involved in the day-to-day operations of a company?

• Analysis of Information provided by Management – A good starting point is to critically analyse the information provided by management at board meetings. Directors must look out for changes in the presentation of information. In instances where there is a major change in the presentation of information which makes it difficult for directors to identify trends, they must ask questions.
• Assess the liquidity position – Directors should insist that the information provided by management is sufficient to understand the company’s liquidity position. They can compare the information presented to them by management to information received about the company from other sources. If there are any changes to the financial performance, these should be assessed in line with historic trends and future potential in the industry.
• Assess other Key Performance Indicators (KPIs) – Directors should monitor the relevant performance indicators that provide information on how well the core operational activities of the company are being performed. These KPIs can be compared to best practice in the given industry to see how well the company is faring. In a situation where adverse KPIs are reported, directors should request for additional information to identify the course of the adverse report and any related challenges that these may signal.

If early warning signs are identified, directors should be proactive in seeking more information so that they can thoroughly investigate any signal. Directors and management must be strategically agile to identify changes within the internal and external environment and swiftly allocate resources to address these changes.[5]

Other examples of warning signs of a company in distress

• Change in regulation that affects multiple aspects of a company’s strategy.
• Recurring losses or reducing profits.
• Not adapting to technology that changes customers’ demand for goods and services.
• An occurrence that significantly negatively affects the brand or trust of a company.
• Significant changes to business models in an industry.
• Decline in share prices or debt ratings downgrade.
• A highly leveraged Balance Sheet.
• High turnover of key management personnel within a short period.

Evaluating the current position and planning ahead

Once the directors identify some warning signs that indicate a potential problem, then the management team should be tasked with carrying out a comprehensive review of the company.

The review will involve assessing the business’ financial and operational position over the past two to three years, reviewing forecast revenue, assessing the competitive landscape, reviewing the competencies of key staff and identifying any emerging opportunities.

The directors will be better suited to understand the options available to the business when they have a holistic view of the challenges they are facing.

In a situation where the company is facing significant levels of distress, the directors can constitute a special committee to assess the problems and find solutions to the issues identified. The directors may consider appointing advisors to work closely with senior management to develop a turnaround plan.

In order for the advisors to be independent, they should report to and be accountable directly to the board. The turnaround plan should focus on identifying available options to address financial and operational challenges being faced by the business.

Components of a turnaround plan and key questions at each stage

Area to consider	Sample questions to be raised by directors to management
Working Capital Management The absence of effective working capital management and poor cash monitoring poses significant risks to any business.   This can lead to a highly leveraged Balance Sheet and lapses in the accounts receivable processes. This stresses the solvency position of the company.	·         Are there any immediate gains that can be derived from working capital improvement? ·         What cash generation options are available in the short to medium term? ·         What are the costs of implementing a cost reduction plan? ·         Are there any industry working capital performance indicators, and how do these compare to the business’ performance?
Capital Structure Companies should review their capital structure considering their current performance and their ability to withstand external risk factors. Typically, a longer payment period from suppliers is more beneficial for a company.	·         Are there any debts maturing within the next 12 months and are any debt covenants likely to be breached? ·         Are any of the company’s financial covenants and repayment schedules negotiable? ·         Can any of the existing financing facilities with creditors be restructured?
Operational Resilience A company’s resilience is tested by turnover of key management staff and failed investments over a shorter period. Operational issues such as contracts with unfavourable terms and lapses along the supply chain can also create excessive stress on the performance of a company.	·         Is management equipped with the requisite skills to identify and address the challenges? ·         Which business units are not integral and can be merged or collapsed to make savings that can benefit other sectors of the company? ·         Where can the company gain efficiency in its supply chain process?
Managing Stakeholders It is more advantageous to ensure that there is transparency with stakeholders such as regulators, suppliers and customers before a crisis unfolds.	·         Where is the company most vulnerable along the supply chain? ·         What is management doing to minimise these vulnerabilities so that the company can continue to deliver on its brand promise? ·         Is the company up-to-date or compliant with regulatory requirements? ·         What measures can be put in place to satisfy the company’s customers whilst still maintaining quality at least cost?
Business Continuity Negative publicity on issues connected to a company creates unpleasant associations with a brand. In dealing with such occurrences, it is more effective to assign a distinct selection of trained staff to manage the negative publicity while other management staff keep the company running.	·         Does the company have a crisis management team? ·         Is there a dedicated team of key management staff who will deal with a crisis if one occurs? ·         How equipped is the company’s public relations team?

 How to lead through the challenges

Directors can initiate strategies focused on boosting revenue, cutting costs, and enhancing working capital management. If these efforts fail to enhance the company’s performance, alternative courses of action must be explored, including potential financial restructuring.

When evaluating restructuring options, the directors should not only assess the current challenges but also anticipate their ripple effects. The company’s liquidity position serves as a vital indicator of its overall health, guiding advisors in outlining restructuring possibilities. Throughout this process, stakeholders should be kept informed of developments.

Restructuring can be pursued informally or using the formal provisions as set out in the Corporate Insolvency and Restructuring Act, 2020 (Act 1015). Informal restructuring typically offers swifter and more cost-effective solutions as compared to the formal process.

However, the option selected would depend on where the business is positioned on the demise curve.  Businesses seeking to leverage informal restructuring would negotiate with creditors and other stakeholders to get to a position where the company would be given a specified time to return to financial health.

Conclusion

Despite the best efforts of executives and management, businesses may face financial, operational, and economic challenges at various stages. Continuous monitoring of a company’s performance is essential for identifying distress signals promptly. Delayed responses to such signals can hamper the company’s ability to address challenges effectively. The collaboration between directors and management is crucial in stabilising the company’s liquidity before issues escalate.

Board members should undertake periodic training to sharpen their skills in recognising signs of financial and operational distress. In this dynamic and ever-changing business environment, board members must ensure that they can recognise the complex issues that companies face and provide the needed support in such times.

During challenging times, directors face heightened scrutiny and expanded responsibilities. As a result, balancing multiple interests to maximise shareholder value is paramount. Experienced advisors can help boards mitigate risks, assess restructuring options, and guide their companies through turbulent times.

The pivotal role of directors in steering corporate affairs cannot be over-emphasised. It is therefore imperative for directors to possess the requisite skills and competencies to identify distress indicators and effectively navigate through challenging situations.

Authors

Augustina is an  Associate Director, PricewaterhouseCoopers (Ghana) LTD,

Member of the Chartered Institute of Restructuring and Insolvency Practitioners Ghana

Gideon is a Senior Manager, PricewaterhouseCoopers (Ghana) LTD

Member of the Chartered Institute of Restructuring and Insolvency Practitioners Ghana

Esther Addei is Manager, PricewaterhouseCoopers (Ghana) LTD

Member of the Chartered Institute of Restructuring and Insolvency Practitioners Ghana

[1] Prabhu, K. Seeta. ‘Managing Development Policies Amidst Poly-crisis: The 21 st Century Conundrums and Challenges.’ IASSI Quarterly 43.1 (2024).

[2] Institute of Directors, ‘What is the role of the board’ (2021) <https://www.iod.com/resources/company-structure/what-is-the-role-of-the-board/> assessed 23 May 2024.

[3] The Economic Times, ‘Adapting to Change: A Leader’s Guide to Thriving in Uncertainty’ (2023) <https://economictimes.indiatimes.com/jobs/c-suite/adapting-to-change-a-leaders-guide-to-thriving-in-uncertainty/articleshow/104731002.cms> assessed 23 May 2024.

[4] PwC’s Governance Insights Center, ‘How can boards help their companies navigate distress – before it’s too late?’ (2022) <https://www.pwc.com/us/en/services/governance-insights-center/library/how-can-boards-help-distressed-companies.html#> assessed 23 May 2024.

[5] K Shimizu & MA Hitt, ‘Strategic flexibility: Organizational preparedness to reverse ineffective strategic decisions’ (2004) 18(4) Academy of Management Perspectives 44.