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The hidden horror story

STEPHEN OAKLEY and Rod Harris have recently taken on finance roles that offer tantalising opportunities, but equally carry substantial risks. They have both joined companies that are in the midst of financial turmoil.

In October, Oakley was named as the new chief financial office of accident management specialist Helphire, months after an independent review revealed that the company had misled investors about its financial position.

Harris, only a matter of months after becoming finance director at Mouchel, found himself in a firestorm at the heart of the consultancy. Since his appointment the company has downgraded its profits, lost its chief executive and seen a new chairman leave after only four days.

In the case of Helphire, the company announced that a “material discrepancy” in the carrying amount of its receivables has been discovered. The result of the accounting blunder was a £27m shortfall on the company’s balance sheet – more than 15% of Helphire’s receivables – and it had to make write-downs of £25.7m for the year to the end of June. The problems at Mouchel arose from an “actuarial error” to the tune of £4.3m, which impacted on a gain the business expected to mitigate the tougher-than-expected conclusion of a number of contracts.

Oakley and Harris could be judged to have taken a gamble by joining companies that are on the financial ropes. Becoming the FD of a company that finds itself in a desperate turnaround situation is something that can make or break a finance director’s career. By taking a firm handle of the situation quickly and decisively, you are perceived as the new broom sweeping away the financial mess of a predecessor, but if the bad news keeps on coming six or 12 months down the line, invariably the taint will be hard to shift.

But there are some notable success stories out there. The likes of Ken Lever and Richard Pennycook have forged stellar reputations for succeeding in turnaround situations. Lever’s 37-year career has spanned senior accounting and executive roles in a throng of plcs, many of which were a turnaround job comprising integrating purchased businesses, restructuring and managing change. Pennycook, the finance director of Morrisons, is highly regarded as a turnaround specialist – notably after Morrisons’ Safeway takeover, and earlier in his career at Laura Ashley, Welcome Break and HP Bulmer.

 What lies beneath

Pennycook’s advice for any finance director joining a company where its financial horrors are starting to come to light is to expect the worst.

“If you go into a turnaround situation, the key assumption is that it will be worse than the outside world thinks. Don’t be surprised when you start pulling the drains up that it is worse than everyone thought,” Pennycook tells Financial Director.

However, there are things that can be done to even the financial odds before setting foot on the premises. Pennycook says that due diligence during the interview process is key before deciding whether to plunge headlong into a financial basket case. He suggests speaking with the outgoing finance director and the chair of the audit committee, and asking to see 12 months worth of board minutes and audit committee meetings.

Suzanne Wood, head of the financial officer practice, Europe, at Russell Reynolds, goes one step further and suggests asking to see the company’s management accounts, finding out what sort of audit report the company has had, and asking to speak with its audit partner.

But due diligence can only take you so far. “You might be preparing for plan A, but lessons from 2009 taught us to have plan B ready just in case,” she says. “Things can change very quickly.”

Part of the problem of doing pre-appointment due diligence is distinguishing between symptoms and causes.

“Poor or unrealistic accounting judgements may be a symptom of an overly optimistic management culture that may be slow to spot deteriorating circumstances and the harsher decisions required. This is quite difficult to assess from a pure external desktop exercise,” says David Tilston, who was interim finance director at Mouchel until June 2011.

Regardless of the limitations, taking the time to conduct your own due diligence is essential in getting a handle on how deep the rabbit hole goes before stepping across the threshold. Relying on the due diligence of others can lead to disasters, as the cautionary tale of one former FD and non-executive director shows.

He tells Financial Director that he joined a business as a non executive that had just completed the prospectus for a rights issue. As a result he took the view that the sponsor of the issue had done a huge amount of due diligence – a view that was compounded by the fact that the company had just written off £80m of poor accounting.

“I thought all the bad things had been got rid of,” he says. “But six months later, we found there was fraud going on and inappropriate accounting taking place.” 

Take the pain

The speed at which the finance director can get a handle of the situation and get any financial skeletons into the open will likely define how their tenure will be viewed. On being appointed finance director at Mouchel, Harris wasted no time in reviewing the company’s contract risks and project claims, and increased provisions by another £4m.

Time is often the one thing new FDs do not have – although most will hope to have more than chief executive and FD of Iris, Neal Roberts, was given when he previously worked as FD of GuardianiT. In his first month in the role he found severe accounting irregularities at the company and a significant overstatement in its forecasting. He was recruited in December 2001 and by the new year had to make his first statement to the shareholders on the severity of his findings.

David Sage, managing director at turnaround specialist Alvarez & Marsal, says that in order to give the organisation a chance to survive, finance directors must articulate what they do not understand and how long it is likely to take to uncover.

“Be up front and get the bad news out the way first,” he says. “Tell stakeholders you don’t know how bad the situation is.”

Tilston adds that hitting shareholders, banking partners and analysts with the bad news early can sometimes be the best medicine, even if it can be quite painful to swallow.

“You are normally better off taking the maximum amount of pain as early as possible and ensuring everyone is grounded in the reality of the situation,” Tilston says. “This may well upset various stakeholder groups, but the best defence is unambiguous honesty.”

Before you can manage market expectations about performance, the immediate priority is getting a handle on the company’s cash position. That is what can kill the business in the short term.

Blowing the business’ banking covenants is a sure way for the company’s share price to spiral downwards. If you have your liquidity position under control, then it buys you more time to get to the bottom of the issues and implement corrective actions.

“The first priority is to make sure you have got the keys to the organisation and pages to the chequebooks. You need to adopt a strategy managing short-term cash,” says Sage.

Getting the bad news out quickly and conducting a detailed review of the company’s books is a fine balancing act.

Most FDs will be given a period of grace to enable them to get to the bottom of the problem. On the one hand, you have to move quickly. Stakeholders will assume that everything is under your belt the first time you announce the annual audited accounts.

The difficulty, however, is that in that time you will not be able to drill down in fine detail, you may not have all the facts and more damaging errors could come out. If problems start hitting the balance sheet six months down the line, it can destroy your credibility.

“From a practical point of view, it is difficult to be seen as a new broom on your first set of results and then come out with more bad news in your next two results’ presentations,” says Tilston. “As a result, FDs will want to move very quickly and ‘kitchen sink’ as much as they realistically can.”

Pennycook agrees it is important to know how far you are from bottoming out of the issue.

“The last thing you want to do is go to market with facts that turn out not to be complete,” he says. “If you are forced to do that it is important you go to the market and say, ‘Here is what we know, here is what we don’t know, and this is when we will be back to update the situation’.” ?

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