How ineffective debt management spelled the end for one CFO

By in Opinion

As advisors, we’re often called in to assist businesses in financial distress, as happened to one of my colleagues recently.  The business in question was in breach of its bank covenants.  The bank was threatening administration and surprisingly the business owners were oblivious.

What unfolded was a tale of avoidance, misstatement, and blind hope.  And like many such cases we found a well-meaning but inexperienced CFO at the centre.

With the blind optimism typical of those that are in more trouble than they realise, the business’s CFO lived in hope that each month’s sales would bring them back into the black.

The business had a loan of $8 million with strict associated covenants.  When it became apparent that the business wouldn’t reach these convents, the CFO ought to have contacted the bank.  Instead, he allowed the covenants to be broken and went on to ignore subsequent communications from the bank including; letters, phone calls and attempts to schedule meetings.

The CFO not only neglected to communicate with the bank but also failed to keep the business’s owners informed.

When the bank finally got in touch with the directors, it was inform them that they were about to be put into receivership.  Fortunately for the business owners, William Buck was able to negotiate with the bank and develop a strategy to set the business back on track.  Over the next few months they successfully traded out of hardship.  The CFO was not so lucky, and was dismissed soon after the issue came to light.

While this was an extreme situation, it highlights the need for good debt management.

Debt can be a highly cost-effective way to fund the growth of a business, and an optimal debt to equity mix will maximise the value of a company.  However, too much debt or debt that is not well managed, can lead to the demise of a business, with the CFO often wearing the brunt of the blame.

So, what can you do to ensure that you effectively manage the debt in your business?

Debt management tips

1.  Have a capital management plan that seeks to reach an optimal debt to equity funding ratio for the business.

The capital management plan will need to be aligned to the long-term strategic objectives of the business and consider proposed M&A initiatives and/or large proposed capital expenditure projects.


2.  Undertake appropriate due diligence before sourcing new debt.

At a minimum, this due diligence should involve preparing reliable cash flow forecasts to demonstrate that the business will be able to service any additional debt. If the forecasts show that the new debt could potentially create an unacceptable level of financial risk, be prepared for the bank to require that you also seek other forms of finance such as, additional equity injections, mezzanine finance, hybrids or sale and lease back arrangements.


3. Maintain a good relationship with the bank

Finance is never just about the numbers.  The quality of your relationship with your banker will be critical when the business needs additional funding to take advantage of strategic growth opportunities or support to trade through a difficult batch.

CFO’s that have the best relationships with their banks:

  • Meet with their bankers to explain their business strategy
  • Remain focused on the strategy that has been agreed with the bank (or explain deviations from strategy with them)
  • Provide the bank with accurate and reliable financial information
  • Do not undertake transactions that may concern the bank, such as material changes to Director remuneration or non-commercial related party transactions, without discussing those transactions with the bank
  • Respond to bank questions on a timely basis


4. Do not hide issues from the bank or Directors/owners

Like most people, bankers don’t like bad surprises. Therefore, if your business does not achieve an agreed milestone or forecast, it’s important to initiate a transparent dialogue with the bank as soon as possible.  If the surprise is significant, such as a breach of bank covenants, we would recommend seeking expert advice on how to best negotiate with the banks and/or potentially restructure any loans.

Hiding problems or ignoring bank concerns around performance issues can lead to a breakdown of trust.  This could result in the appointment of a Receiver and Manager (R&M) in a situation that could have been avoided had the issue been better managed.


5. Don’t assume that your debt will be rolled-over

Too often we notice that clients just expect that their loans will be rolled-over once their existing facilities expire.  However, a bank’s appetite for continuing to provide a loan is often dependent upon many factors, including; the outlook for the relevant industry, the borrower’s risk profile, the level of security provided, the company’s history of meeting banking covenants and record of providing reliable information to the bank.


6. Ensure that you are getting the best terms from your bank

Sometimes CFO’s can become complacent with their funding arrangements.  A regular assessment should consider:

  • Whether your loan prices and terms are competitive having regard to the credit risks of the busines
  • The use of other funding products, such as options, to manage foreign currency and interest rate risks
  • Whether the level of security provided against the debt is higher than it needs to be?

An effective capital management plan minimises financial risk releasing directors and shareholders from any unnecessary personal guarantees, whilst improving the profitability and value of the business.

1 Comment

  1. Andrew 4 years ago

    I concur with the writer’s tips although first & foremost the relationship with the bank is critical. Banks hate surprises & early forecasting a breach can sometimes allow a revision of covenants – banks don’t want their covenants breached either. If a breach is imminent you must present the bank with a plausible plan & more importantly action it. Under-promise & over-deliver! Regular honest & accurate communication is an absolute must, particularly if an IA is appointed as there may be conflicting agendas. Banks will work through a distressed situation only if they truly believe that you have their interests at heart. Sending a business to the wall isn’t usually in their interests. Expect it to be a long rough & tough road but if you do what you say you will do it is more likely a bank will support you throughout the process. Wander off the road at your peril!

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