La PKC actua principalment sobre els agrupaments d’AChRs i no directament sobre els axons

According to Kirk (2015), there are three fundamental building blocks to a successful return to financial health. They involve three operational strategies: ensuring sufficient short-term liquidity, reducing long-term gearing, and increasing profitability.

4.5

Cash flow

Liquidity was found to be the first concern of most of the companies. All respondents pointed out that access to additional capital is top on the list of factors necessary for a successful recovery in the construction industry. For example, respondents’ comments on liquidity:

“The immediate plan was to improve the working capital of the company”

“I’d say first of all you’d need the support of investors whether that’s the bank or whether it’s a financial institution… access to additional working capital... It’s cash that kills you,

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not profitability. You can trade effectively with a continuing loss as long as you maintain the cash position.”

All 24 respondents said their first action for operational recovery is to increase working capital (Cash flow) by any means possible. Clearly, from our financial analysis, improving working capital/Cash flow is the most important part of the turnaround endeavor among the cases within this study. Improvement on working capital improves the Z-score and therefore company financial health and vise versa. The most common definition for working capital is current assets less current liabilities. This formula is supposed to give a clue as to the liquidity of the company. However, this may be misleading. Not all current assets are liquid; stock, debtors and work in progress are not easily converted into cash in some instances, as such a company may still have a shortfall in Cash flow even when the working capital looks healthy. Therefore the change in working capital is what’s important because that tells the cash flow position of the company. The true test of liquidity is ‘Cash’ – how much cash is in the hands of management (Ross and Williams, 2013).

Thomas, (2013) and Sears et al (2015), state that Working Capital as it is, tells us very little. Therefore, it is better to look at ‘working capital’ from how it changes over time. That is, the ‘change in working capital’ is what’s important. According to Sears et al (2015), house builders have a ‘positive working capital requirement’. That means, a house builder would usually need additional cash to grow and would normally have a positive working capital since the firm would have paid all the costs of building the houses in advance before selling it. Positive working capital also depicts ‘negative change in working capital’, where operating current assets are increasing by more than operating current liabilities. On the other hand, a contractor has a negative working capital requirement (positive change in working capital), where operating current liabilities are increasing by more than operating current assets. This is because, the contractor can generate cash to grow through advance payment, whereas the house builder needs additional cash grow. A positive working capital (negative change in working capital) is particularly bad for a contractor because it decreases cash flow and it indicates that a company has too much cash tied in stock, and/or has too much cash in the hands of debtors. Unless a contractor has plenty of cash reserve to meet obligations as they arise, the company could be in trouble. For the house builder, a negative working capital (positive change in working capital) is not so good because it means that

176 there is more payments to make than receipts, less stock to sell and therefore little money coming in.

Recalling the concept of negative working capital in Chapter 2, for contracting firms, negative working capital (positive change in working capital) could be a sign of management efficiency, where the company has a good line of credit from the supply chain and turnover increases thereby increasing deferred income, and the excess cash is invested in fixed assets or other long-term investments (Sears et al, 2015; Thomas, 2013). The difference between the disbursements and incomes would result in a negative or a positive (excluding cash and debt) operating working capital, which shows how management manipulates the company’s current assets and current liabilities to fund its on-going operations. This manipulation of assets and liabilities shows the net effect on cash flow. Investors and lenders usually pay attention to a company’s Change in Operating Working Capital to determine its free cash flow whether a company can consistently reproduce high return on investment (ROI) and therefore to lend or not.

That is why this research has looked at Cash flow from the change in working capital point of view. A company with assets greater than liabilities can still fail if it does not have sufficient cash to meet obligations as they fall due (Kirk, 2008). Now, change in working capital looks at the current asset section of the balance sheet as a cost to the company (excluding cash) because, effectively, the company is spending cash. Whereas, on the current liabilities section of the balance sheet, effectively the company is getting cash and therefore increasing in cash flow. Consequently, negative change in working capital decreases cash flow as current assets increase more than current liabilities and the opposite is true for positive change in working capital. To be explicit, positive change in working capital increases cash flow, as such, the increase of current liabilities over current assets is better for cash flow. This may sound counter-intuitive, since it may require borrowing additional funds to repay short-term debt and finance ongoing operations. But the company will still be liquid and would have money at its disposal to finance its operations. Which is better than having no debt but not having the money to finance operations and ultimately means insolvency, if not in the long-term, at least in the short-term. Hence, the immediate priority for contractors especially those in a turnaround process is to ensure the liquidity of their companies by keeping change in working capital ‘positive’, unless they have a lot of

177 cash in their reserve to supplement for cash flow shortfall. The contractor must have guile in doing this so as not to become overleveraged, upset subcontractors and suppliers for delays in payment, and/or be seen by clients as too demanding in terms of payment. On the other hand, it is in the interest of the house builder to keep change in working capital ‘negative’ so he has a good amount of stock to sell to make profit. However, if the house builder’s change in working capital becomes positive, he would require a cash buffer or would need to get additional cash to meet obligations.

This is true for the industry at large. Cash flow plays massive role in the survival of both large and small construction companies. Now lets look at the companies in terms of Cash flow in the decline and turnaround years. The first three companies CB1 construction, HFB2 construction, and BH3 construction are all traditional house builders, while all the others are Contractors (contracting companies).

A contractor with negative change in operating capital runs the risk of short-term insolvency as assets exceed liabilities, if he/she cannot get work. This is because a contractor does not have large amounts of stock to generate cash when Cash flow drops (Sears et al, 2015; Thomas, 1013). Also, part of the problem for the contractor is that, much of company’s current asset is made up of account receivables (trade debtors), which means that a contractor with a growing operating working capital, is waiting too long for payments and may not be able to pay his/her bills, unless he/she has a decent cash reserve or borrows additional funds to augment Cash flow. The contractor with a negative change in working capital has flipped the contractor’s business model and is at risk of failure unless the change is not significant enough to impact cash flow, and the company has a decent amount of cash and/or borrowed money. A house builder with a positive change in working capital runs the risk of short-term insolvency because he does not have the ability to generate cash like the contractor, but relies on his stock levels to generate income and profit, and when that is no more, the house builder is out of business.

Table 4.7: Change in Working Capital: Decline Years

Companies Year Change

in WC % Of Turnover Opening% of Cash/CL Opening % of Debt/CL Z-score U CB1 Construction 2007 +ve 20.8 0.11 60.8 -1.06

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HFB2 Construction 2010 +ve 119.6 4.63 96.9 -5.27

BH3 Construction 2009 +ve 109 0 47.5 -7.17

GCE and Co.

Construction 2004 -ve -7.12 6.66 0.57 0.20

AWH5 construction 2008 -ve -1.41 33.4 0.75 2.09

EJ6 Construction 2011 -ve -0.33 0 35.7 0.16

CDJ7 Construction 2010 -ve -6.93 0.09 8.05 -0.96 SBW8 Construction 2008 -ve -0.79 0 8.01 -0.81 MK2 Construction 2014 -ve -23.2 0.01 57.2 0.92 LD3 Construction 2014 -ve -4.39 3.41 5.7 0.31 Success ful Turnaround BT1 Construction 2010 +ve 7.47 18.0 0.66 -0.77 TG2 Construction 2009 +ve 0.90 50.6 1.63 0.46 CM3 Construction 2008 -ve -19.6 74.3 0 0.59 GP4 Construction 2010 +ve 9.25 45.8 38.3 0.85 CV5 Construction 2005 -ve -2.86 29.8 28.9 0.17 CG6 Construction 2008 +ve 7.87 9.58 0.35 0.98 CF7 Construction 2006 +ve 8.37 0.04 10.5 0.58

CI8 Construction 2007 -ve - 35.2 0 1.20

TW9 Construction 2007 -ve -2.64 10 49 1.22

For example, in Table 4.7 above, all the unsuccessful turnaround contractors had a negative change in working capital, and, all the house builders had a positive change in working capital in their respective decline years. They flipped their working capital requirements upside down. The contractor in recovery is supposed to maintain a positive change in working capital and the house builder, a negative change in working capital to ensure increase in cash flow. Those construction companies that waver into the other sides of their working capital requirements usually have a lot of cash or debt to help with Cash flow so that when operating Cash flow is low, they inject more cash into the cycle. From Table 4.7, successful turnaround companies like CM3, CV5, CI8, and TW9 construction all had a negative change in working capital in their respective decline years but they all had a good cash balance that were; 74.3%, 29.8%, 35.2%, and 10%, of current liabilities respectively; to cover for the shortfall in cash flow. Their cash reserves enable them to inject more money into the cycle and turn their companies around. Consequently, the companies’ corresponding cash levels dropped except for CI8 where its cash level increased.

179 Furthermore, CV5 and TW9 had good amounts of borrowed money to help with any cash flow issues.

Now contrast that with those companies that had no cash to help with cash flow in their decline years, and relied entirely on their operating cycle for cash flow. These companies usually fall into trouble when they sway away from their working capital requirements. For example, all the unsuccessful turnaround companies had very little cash or no cash, except for AWH5 construction whose shareholders made a business decision to close the company down as the market looked bleak. The rest of the unsuccessful turnaround companies had no cash and therefore needed to maintain a positive change in working capital to boost cash flow in order to survive. But evidently, they could not do that, and consequently could not recover.

On the other hand, companies like CG6 construction and CF7 construction who had cash level that were; 9.58% and 0.04% of current liabilities respectively; and had little borrowings to help with cash flow, maintained a positive change in their working capital thereby boosting tbeir cash flow. Consequently, the respective company management teams were able to keep cash within the company to fund the turnaround. For companies like BT1 construction, TG2 construction and GP4 construction, they all boosted their cash flow levels by keeping change in working capital positive, at the same time having significant amount of cash (18.0%, 50.6%, and 45.8% of current liabilities respectively) readily available for management to use for the turnaround.

Table 4.8: Change in Working Capital: Turnaround Years

Companies Change _{in WC Turnover}% of _Cash/CL% of _Debt/CL% of Z-score

UT

KUP1 Construction 2014 +ve 1.41 14.6 0.54 1.22

MK2 Construction 2010 +ve 15.5 0 64.7 2.54 LD3 Construction 2013 +ve 1.74 0 29.1 2.15 Success ful BT1 Construction 2011 +ve 5.70 34.6 2.01 1.43 TG2 Construction 2010 +ve 4.49 36.7 2.95 1.38 CM3 Construction 2011 -ve -2.03 34.7 17.6 1.77 GP4 Construction 2011 -ve -35.8 54.1 16.5 1.94 CV5 Construction 2011 -ve -1.20 0 42.8 1.35

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CG6 Construction 2010 -ve -4.92 40.1 0 1.41

CF7 Construction 2009 +ve 1.77 0 11.5 1.78

CI8 Construction 2008 -ve -21.9 50.8 0 2.45

TW9 Construction 2008 +ve 6.0 0.88 41.2 2.39

Now Table 4.8 shows the turnaround years. The unsuccessful turnarounds (non-liquidated companies) KUP1 construction, MK2 construction, and LD3 construction, all had positive changes in working capital thereby boosting their cash flow and giving themselves a chance at recovery since their cash levels are quite low (14.6%, 0%, 0% of current liabilities respectively). However, a few companies in the successful turnaround had negative changes in working capital in their respective turnaround years. These companies are: CM3, GP4, CV5, CG6, and CI8 construction. Their respective cash levels to current liabilities are: 34.7%, 54.1%, 0%, 40.1%, and 50.8%. These companies can afford to have negative changes in working capital because they have a lot of cash to augment Cash flow, except for CV5 construction that resulted to borrowing (bank loans and overdraft) for cash flow, with 42.8% of its current liabilities made up of borrowings. Also, the changes in WC as a percentage of turnover are negligible and would not make much of an impact, except for GP4 with a -35.8% of turnover. Even so, GP4 will still be fine because of its large cash and debt balance.

It is important to understand that a contractor that relies entirely on his operating cycle needs to always have current liabilities increasing by more than current assets (positive change in working) in order to survive a downturn. The company must try to get extended lines of credit from the supply chain and must never be in haste to pay subcontractors or suppliers unless it gets paid first (pay-when-paid strategy will be discuss in a later section). The contractor should ask for payment up-front or negotiate shorter payment periods.

Negative change in working capital as a percentage of turnover, when very high, could have very significant impact on a construction company’s cash flow. Companies that had high negative changes in working capital relative to turnover in their turnaround years like GP4 and CI8 construction (-35.8% and -21.9% respectively) ran the risk of failure particularly because the change was considerably high. Meaning the impact on cash flow would be high. The impact of diminished Cash flow would have been greatly felt through out the companies had it not been for their huge cash reserves (54.1% and 50.8% of current

181 liabilities respectively). In contrast, unsuccessful turnaround companies like CB1, HFB2, and BH3 construction, who are all house builders, whose positive changes in working capital as a percentage of turnover were: 20.8%, 119%, and 109% respectively, had little or no cash reserves to inject into the business. Therefore, the impact on cash flow was enormous. Consequently, the companies could not continue trading and could not recover.

Granted, not all construction companies can get advance payment at the start of a project and therefore have to finance the clients’ project at the start before getting paid at a later date by the client. This space of time has been estimated to be between 7-8 weeks. That is why most of the successful turnaround contractors believe that the best asset, or best quality of assets is Cash. For example the change in working capital for EJ6 construction is negative because it is common practice for the company to start financing projects before receiving payment. The Director was asked if in the current financial situation, his company finances its projects from the start or does it ask clients for advance payment? He stated

“No we fund the project with our own money. When we set foot on the site and start the job it’s probably, at least, generally about eight weeks before we get money from the client and get us our first payments. So we finance it basically ourselves.”

This practice is not uncommon, but it does require the contractor to have a strong buffer – a good amount of cash to fall back on when things go wrong. For example when there is a delay in payment or bad debt, the company has a safety blanket. However, EJ6 construction had no cash at all and therefore when things didn’t go as planned, the company could not continue trading. Consequently, it went out of business.

4.6

Gearing

This section is mainly focused on understanding the capital structure of companies, the types of debt they subscribe to. Almost all of the unsuccessful turnaround companies are highly leveraged due to the aggressiveness of the management teams. In the end, the companies were more than a hundred percent geared and were left at the mercy of the banks. Companies that were extremely geared at the time of failure were CDJ6 and SWB8 construction. The former Financial Director of BH3 construction explains his company’s cross-collateralization at the time of failure:

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“It started out at 65% when the facility was negotiated but very quickly we needed that percentage to increase to prevent us having to repay the debt”

When he was asked to rate the level of debt on a scale of 1 to 10, his answer was:

“It was far far far too high. It was 10. I mean it was too high.”

The case of extremely high gearing is not a new one. Cash flow shortages make high gearing levels evident.When a firm is overleveraged and cash flow falls, it can be very dangerous and the outcome is almost always bankruptcy. The Capital Structure of BH3 construction was a hundred percent debt. In this type of situation, the usual reaction is to try and offset the debt by seeking new equity or debt for equity swop. The strategies used to attract new equity are discussed in the next chapter. However, there is no guarantee that any of the strategies will work, as construction is not an industry that is favored by investors at a time of recession.

It is imperative to understand that improving operating level cash flow is only one aspect of improving the overall cash position of a company. Actually, much of the strategies to improving working capital (cash flow) is in: cost cutting, cost reduction, debt repayment, cash management, equity finance, bank loans and overdrafts etcetera, which will be looked at shortly. However, debt repayment plays a very important role in reducing the gearing level of a company. According to Kirk (2015), the next step after improving cash flow is to reduce long-term gearing. “Once the immediate dangers of cash flow have been managed”, he said, “the aim is to reduce levels of medium and long-term debt”.

Repayment of debt can take different dimensions (discussed in a later section) as management tries to get enough cash to pay for the debt and fund on-going operations. According to Clough et al, (2005), gearing levels between 1-50% are generally acceptable in the construction industry. Gearing levels above 50% is generally regarded as highly