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Insolvency – how to protect and survive

12 February 2010
Insolvency – how to protect and survive

The majority of small and independent hotels fail to spot the warning signs of an impending financial crisis and take action too late. Jean-Pierre Van Der Rest and Jan Adriaanse look at what measures you can take to ward off insolvency.

Although previous predictions of a bloodbath of failing businesses have not come to fruition, many small operators are facing liquidity problems. It is crucial that they take action in time if there are warning signs of trouble, such as a significant change in the market

The amount of insolvencies around the globe increased sharply in the second half of 2009 and it seems that it will remain high in 2010.

Some hotels may have to ward off demise. Half of them will generally manage to regain a healthy position; the other half will finally go bankrupt. Even though previous predictions of a bloodbath of failing businesses have not come to fruition, the question of what turnaround measures hotels can take in the light of potential liquidity problems is still very relevant.

A survey of 2,600 CEOs found that companies in crisis take action 16 months too late on average. While 17% said they would only take action when the money is nearly finished, 54% said they would do so when the income statement deteriorates.

Only 29% act at a strategic turning point, such as when a significant change in the market is foreseen or when competitors seem to be creaming off market share on a permanent basis. At these moments the company is still earning money and there is scarcely a liquidity crisis. However, if action is not taken, strategic weaknesses may develop that come home to roost later. This has been patently obvious to some small and independent hotels. So, what can they do?

RECOGNISE PROBLEMS ON TIME

When we consider problems in salvage operations, managers are often loath to take rigorous measures. Also, they remain in the denial stage for too long.

Successful entrepreneurs are aware of difficult situations in time and are not afraid of reorganising quickly and adequately. Others only see the problems fully when a bank forces them to reorganise or when they are placed in receivership.

TURNAROUND PLANNING

The success of a salvage operation also depends on the way management tries to make the hotel profitable again. In practice this means making a plan of approach, based on a long-term vision, and aligning activities in the areas of marketing, product and service innovation, sales, finance, operations and human resources. Such a plan serves two aims only. It reduces costs and improves turnover both qualitatively and quantitatively on a structural basis.

But in practice when financial problems are critical, the focus too often lies in cutting costs as fast as possible. Although this is understandable psychologically, it must be clear that in addition to cutting costs, increasing turnover usually offers better possibilities to increase profit and cashflow.

Structured and deep consideration of a hotel's capability to deliver (or extract) customer value should always be paramount, particularly in times of recession. Furthermore, the seriousness and nature of the crisis will largely determine the order and urgency of the measures to be taken.

However, no hotelkeeper should forget that the raison d'être of a hotel always emanates from its ability to predict needs in the market. A reorganisation plan must therefore always be based on existing clients and new target groups.

COMPLETE TRANSPARENCY

Make sure that stakeholders (eg, lenders and major suppliers) can always estimate and weigh their own risk of losing their money. Provide complete transparency, confidentially and early on, with regard to the current financial situation and the planned financial reorganisation. You have to avoid a situation where they pull the plug too early.

Avoid too much uncertainty about the viability of the hotel. If there is not enough clarity stakeholders are likely to refuse to co-operate.

FINANCIAL RESTRUCTURING

In a liquidity crisis do not immediately seek agreements for discharge of debts. Always first look for solutions that maintain debt and eventually the repayment of existing debts.

Try to attract equity capital to reorganise the balance without partially or completely discharging the creditors' demands. New equity - from shareholders or new investors - will reduce the risks for (future) creditors and generate additional liquidity. Of course, this can only happen when there is enough trust in the potential of the hotel to survive.

A salvage or turnaround operation is primarily dependent on restoring and winning trust, with regard to the ability to be profitable in future and with regard to the management. By contacting stakeholders early on, by creating insight into the financial situation and the reorganisation plans, by communicating proactively about progress during the reorganisation and adopting an attitude that shows that you are not simply passing the buck of entrepreneurial risk to the creditors, the chance of conflicts is reduced along with the chance of bankruptcy.

In fact, repairing troubled relationships is one of the most essential elements of any salvage and turnaround operation. Otherwise, out of cash + out of credit = out of business.

Jean Pierre van der Rest is professor and department chair at Hotelschool in The Hague.

Jan Adriaanse is associate professor at Leiden University and an associate senior consultant with the WissemaGroup management advisory bureau in The Hague.

10 TIPS FOR SURVIVAL

1. Reduce the risk of bad debts Know your customers and their ability to pay. Don't fall into the trap of thinking this process begins and ends when you sign them up to your terms of trade. Keep close enough to them so that you're aware of any changes in their ability to pay.

2. Recognise the early warning signs Pay attention to warning signs from both customers and suppliers so you can spot trouble in advance.

3. Review your staffing costs Have you explored the costs of outsourcing some of your functions? Can you reduce the head count? Can you reduce hours? Is it feasible to reduce directors' salaries?

4. Re-visit supplier contracts Can you renegotiate prices? Credit terms? Order sizes?

5. Review taxes payable Taxes are often a significant cost. Have you talked to HMRC about the possibility of deferring payment when cash is tight?

6. Monitor cashflow A lack of cash is often the downfall of many great empires. Have you applied the "2% rule" to your business? That is, what effect would a 2% increase in prices have on cashflow? What effect would a 2% decrease in debtor days have on cashflow?

7. Capitalise on emerging markets Have you identified the emerging markets in your industry (cheaper components, second-hand markets, money-saving ideas)? Are there new market opportunities you could capture by adjusting your service offering or by creating joint ventures with other companies?

8. Competitor review Are you monitoring your competitors' performance? Could you pick up any of their customers?

9. Green shoots preparation Have you identified what your capacity is for capturing any business resulting from an uplift in your particular industry (even if it's a temporary uplift)? Have you ensured enough flexibility in your capacity to respond to changes in the market?

10. Cash is King Ensure you have built up sufficient cash reserves or negotiated facilities with your bank now so that when trade starts picking up, you will have sufficient working capital to service the demands of a growing business.

John Alexander is a partner at accountancy firm Carter Backer Winter

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