Last month PwC published an excellent report on the role of the Board of Directors in identifying when the company they serve might be entering a period of distress or is already in trouble. Further, the report outlined the board’s role in helping companies turn the situation around and minimize damage.
The challenge for directors is being able to spot potential trouble even though they’re not involved in the day-to-day running of the company. The fact that boards typically meet quarterly and rely on reports provided by management may further hinder directors from spotting trends and patterns that might reveal a potential issue.
Yet looking into the future on behalf of the company should be a key activity of today’s boards and, fortunately, there are plenty of warning signs that can signal to directors the need to look deeper.
For example, errors or misstatements in the financials can be an indication of issues within the financial department that may be impacting the integrity of information. Other financial metrics such as performance that’s lower than projections and/or lower than the prior year, thin margins, increased unit costs and recurring losses, can also be signs that all is not be well with the company, even though management may be painting a brighter picture.
Here are a few additional signs PwC suggests boards be on the lookout for:
- Excessive turnover, particularly in management, and also within a short time period.
- New competitors entering the market with the potential to cause disruption.
- New regulations that apply to many aspects of the company’s strategy and which will up-end the business models the company employs.
- Failure to recognize and respond to technological innovation – especially innovation that will permanently shift consumer/customer behavior and demand.
- Declining trust in the company caused by any number of factors, including an ongoing investigation, heavy debt, downgrade in credit rating and analysts or activists consistently identifying the company’s weaknesses.
A board that’s watching for these indicators of potential trouble will be better able to help the company stay ahead of change and challenges and take action before it’s too late.
So how can board members stay abreast of the company’s situation?
Adopting a strong proactive stance is a good operating policy. For example:
- Rather than asking that financials in typical public filing formats be included in board packets, request summary level information that shows trends and patterns over time. Presenting relevant metrics in a way that tells a story is ideal. This can be accomplished using visuals such as a simple line graph that conveys trends for important ratios over time.
- Rather than looking only at whole numbers, look at variances. Look at margins and ratios in addition to numbers. This is key because when volume increases it can hide what’s going on underneath. So examining differences and margins as opposed to looking only at the bottom line can reveal important information such as margin pressure that might otherwise be missed.
- Rather than focusing narrowly on the company, take a broader perspective. This might include studying the industry and overall business environment, as well as keeping tabs on competitors and the company’s reputation.
Another proactive action the board can take before trouble rears its head is to up the stakes during scenario planning.
Interestingly, the PwC report notes that “during the financial crisis, directors observed that the worst-case scenarios the management teams were providing often weren’t nearly bad enough.”
While PwC offers this insight as a caution to boards of companies already in distress, it’s also a concept for board members to keep in mind generally when helping management plan and prepare since outside perspectives are so valuable for expanding thinking and generating more potential options.
Being on the watch for trouble is, of course, only one piece of the crisis puzzle. What is the board’s role when a crisis does occur?
The PwC report details the board’s responsibilities in multiple situations that might require a thorough turnaround plan and possible restructuring and/or insolvency, as well as an overview of what happens when companies go bankrupt. For now, though, here are just a few things boards can do when all signs point to trouble:
- Ask management questions: Because it’s often difficult to navigate a crisis when you’re in the middle of it, simple, straightforward questions from directors to managers can provide the focus that’s needed to help management formulate a plan of action.
- Facilitate difficult conversations: During troubled times, directors can also help make sure any elephants in the room are addressed and that underlying issues are surfaced and discussed.
- Be a moral compass: How the board behaves and how it helps management respond to a crisis can mean the difference between the company coming out of a crisis with a ruined reputation versus a reputation that’s even stronger than it was before.
A final thought:
A high-functioning board will of course perform better than an average board during challenging times. While it’s true that a crisis can sometimes bring out the best in a board, it’s far better to work on board performance before there are signs of trouble. Plus, when a company is facing challenges, directors are only going to get busier and their full focus needs to be primarily on the issues at hand.