Co A’s bold and reckless move resulted in overexpansion, draining its internal resources, and setting the company up for more loans. With new loans came high leverage.
When developers become more obsessed with toplines, they court danger.
A CEO must not be misled by the notion that higher sales automatically mean higher profits. When developers continue to grow their portfolio without adequate cost control, you can expect an impacted balance sheet. Critically, increasing volume and share of the market without looking at the margins can spell trouble.
FOCUS ON CONTROLS
Cost controls are among the most important tools companies must use to manage projects. Ignoring the system can set your cost structure back significantly. There are several costs for each activity and the most common are marginal, opportunity, and variable costs. Unfortunately, few professionals understand them.
Other issues related to a failed cost information is when there is neglect in managing the cost dynamics of any housing development. For example, a vertical development that exceeds a certain height can translate to higher costs, compromising margins even before the project is launched.
Every development must always pursue certain sweet spot variables. The key is to initiate the proper control process guided by the timing and expert intervention.
In the case of Co A, the founder/CEO's lack of cost discipline and his overzealousness to expand contributed to the company’s eventual downhill.
When the founder/CEO became more aggressive, the company had no other option but to inject cash into the business at approximately the rate it was expanding. Crudely speaking, if Co A employed a capital base of P2 billion and was expanding at 20 percent annually, then effectively it needed P400 million in cash to finance capacity, creditors, advance payments, capital expenditures, and so on.
If the objective was to generate a reasonable return of 20 percent on capital employed, it had to apportion taxes and other expenses and dividends plus money for the planned expansion. When Co A decided to ramp up expansion at a faster rate, its internally generated cash flow could no longer sustain operations. Its only recourse was to borrow.
The founder/CEO knew that his debt load was increasing and creditors were already cautioning him but he continued anyway hoping he could nurse the business back to health. And as we dug deeper, we discovered that the senior management team failed to recognize the pressure that was building internally. Co A’s bold and reckless move resulted in overexpansion, draining its internal resources, and setting the company up for more loans. With new loans came high leverage. Poorly managed companies tend to leverage their equity beyond the prudent level.
And when an economic challenge like the global financial crisis struck, a chain of events led Co A to its demise.
Summarizing the debacle, we concluded the following red flags or adverse issues that brought the business to its knees namely: declining margins, drop in sales, increasing debt burden, decrease in working capital, high management turnover, and high buyer attrition.
In conclusion, the team decided that something out of the ordinary was required to save Co A. Time was a major variable if we were to initiate a turnaround. Any period of hesitation can be costly if it was prolonged. With our team in place, we immediately buckled down to work and instituted these ICU (important, critical, urgent) initiatives
It can mean either changing the management or the management changing the way they do things. In my experience doing turnaround or receivership work, the former was the way forward. We recommended the replacement of the founder/ CEO and the removal of several senior executives with high salaries without prejudice to summoning and filing cases against them should we uncover anomalous transactions.
IMPACT AND RISK ASSESSMENT
To keep the company above water, the team started improving and preserving Co A’s cash position. Our focus was to determine—by way of a full audit—the liquidity risks, working capital requirements, project costing, asset accounting, and cash flow forecasts.
We then quickly focused on tight cost and overall control with the objective of improving the cash flow. A blueprint to streamline and improve operations was put in place including a plan to reduce expenses. The initial target was to slash operating expenses by 20 percent but as we gained traction, we then increased our reduction plan to 30 percent.
We conducted an organizational audit to determine the underlying weaknesses. In my experience, the earliest warning signal of a decline is the rapid turnover of people, especially at the middle management level. When operations personnel started to leave Co A even before the global financial crisis happened, we knew that a big cover-up was happening.
To renew scarred relationships with buyers and homeowners and to mitigate buyer attrition rate, we invested on strengthening the support groups which included sales and account management, and customer service.
After studying the longterm capital structure, we started unloading assets to pare debts.
We designed tools to increase cash reserves while ramping up new revenue drivers via joint ventures and optimizing existing land bank.
We took out most of the passive directors (family members) and replaced them with independent directors who were vetted based on their proven experience.
The author is an Asean advocate for real estate best practices; executive director of Wong+ Bernstein Advisory Group; and senior advisor for Post and Powell Fintech Group based in Singapore.