BEYOND EXCEL SPREADSHEETS

Quality of Earnings Report Should be Paired with Operations Diligence

The importance of a Quality of Earnings (QoE) report cannot be overstated.  They are ubiquitous.  The report is a key tool in understanding the health of a business, but it is not the only tool.  Beyond the clarity a QoE delivers on the buy-side, it can also provide sellers with a third-party’s view of potential areas for concern – areas that can be targeted to maximize the company’s future market value. 

The QoE report contents are the same regardless of who requests it (or should be!), and that information provides a full picture of the business financials with key insights into aspects of the company’s operations… or does it?

Operations Diligence – It’s not Sexy, but the ROI is

Foreseeing future negative surprises and understanding the true hidden value within an organization’s operations are essential to protecting and unlocking future profits.  Sounds simple, however it’s not sexy work and is best done by functional experts who are deeply versed in the questions to ask and things to look for.  When dealing with operations planning, it’s important to understand WHY something is done the way it is before plans are made to improve it.  It’s important to dive deep into the operations and identify future negative surprises, quantify ops challenges, and qualify whether the challenge is worth solving.  Furthermore, it’s important to identify and quantify hidden value worth claiming – before a single employee is added or piece of equipment or machinery is purchased. 

Enhancing EBITDA through operational improvements, albeit not sexy, is not only a proven way to increase ROI, but is also a critical cash flow lever in today’s environment of lofty purchase price multiples.

The Check you Write and the Check you Get:

Buy-Side

Beyond the third-party expertise of a thorough operational review by industry veterans, our process involves great, collaborative communication with both the buyers AND the sellers (and their associated service providers and investment bankers).  We are often viewed as a relationship bridge, helpful to both sides of the deal.  Buyers will sense that we seek a practical understanding and appreciation for all they have achieved with their current operations.  We’re a fan of entrepreneurs, and our passion and enthusiasm for understanding their processes are genuine.  We work to document the “as-is” and seek to claim the “could be” in operational value.   As a result of our work, buyers will have confidence in the check they write, and knowing the potential cost to generating the results they wish to achieve.

Sell-Side

We work with sellers to provide support and objective assessments that identify and quantify the impact of implementing operational improvements, which will provide exponential value in the selling process.  We provide a fresh perspective and fine-tuning of operational processes, documentation to expedite the operational diligence process, and a dry run, in anticipation of tough questions that may occur during negotiations.  As a result, we help sellers reveal the value that’s hidden in their business and increase the potential to receive checks with extra zeros on the end.

The ProAction Group, and its Operational Diligence, provides a proven process for achieving exponential value for companies in a wide range of industries and sectors, including manufacturing, distribution, and business services.

We invite you to reach out to our team anytime to start a conversation about the benefits an Operational Diligence can bring to your company, as well as any related services we may provide, to help buyers buy and sellers sell.

• The end of the year brings time for reflection and openness for doing things differently in the new year. Do you have a portfolio company (Portco) that is underperforming and needs help determining the problems and solutions to get earnings back on track?
• At the ProAction Group we bring the Action. We provide momentum, process, and tools to impact results with our industry leading experts who will work with your existing team to guide companies through operational improvements.
• Check out the Conferences we will be attending. Hope to see you there.
• There are no surprises in the deal when we provide “The Knowing” through a DeepView Diligence.

Morgan Stanley reported Monday that jaw-dropping inventory levels are a key risk to retailers, and there is a 19% discrepancy between inventory levels and sales growth.  Additionally, according to Descartes, which aggregates U.S. Custom data, reports that US imports sank in September and posted the steepest drop since 2020 lockdowns.

The headlines are daunting. 

We can chalk this up to skidding demand amid a lot of inventory.  The reverse bullwhip effect that many predicted back in May.   

Companies with high consumer exposure have slashed their ordering — even though this time of year tends to be when retailers are beefing up their warehouses ahead of the holiday season.

According to the Morgan Stanley Shipper Survey, in which some 100 corporations regularly share their transportation needs and macro expectations, net ordering levels have reached the lowest point in the survey’s 12-year history. Ordering levels are down 40% year over year. Net inventory levels are also unusually high.

The report offered guidance, “Faced with a glut of inventory, companies will need to decide whether they want to accept high costs to continue holding inventory, destroy inventory, keep prices high and take a hit on the number of units sold, or slash prices to stimulate demand. We believe many will turn to aggressive discounting to solve their inventory problem which is likely to spark a ‘race to the bottom’ as companies attempt to cut prices faster than peers and move out as much inventory as possible. This dynamic will weigh heavily on margins and fuel the earnings slowdown.

How do you maintain, but ideally grow EBITDA in this challenging environment – make the operations more efficient? That’s where we can help. 

Our team at The ProAction Group works with organizations to identify operational performance improvement processes that get an immediate 22-40% performance gain without adding a single employee or piece of equipment.

We will be honest.  This is a lot of work, and it will require some meaningful changes on your part.  If this truly is a problem worth solving, let’s talk.

We’ve got some key insights and questions to ask at your next leadership meeting

Former Chicago Cubs Coach, Joe Maddon famously told his Cubbies “Try Not To Suck” as a light-hearted way to inspire action.  Simple and direct.  His leadership ended the 100-year Cubs World Series drought.

Economists are still dancing around the issue, but the reality is we are likely headed into a recession.  As businesses survived the worst of the pandemic, the murder hornets, civil unrest, supply chain issues and sky-high energy prices – now comes the recession.

What does history tell us?  As you lead a portfolio of companies, “trying not to suck,” is a low bar.  You’ve got pressure to make sure the results are there for a winning exit. 

In their 2010 HBR article “Roaring Out of Recession,” the researchers found that during the recessions of 1980, 1990, and 2000, 17% of the 4,700 public companies they studied fared particularly badly: They went bankrupt, went private, or were acquired. But just as striking, 9% of the companies didn’t simply recover in the three years after a recession—they flourished, outperforming competitors by at least 10% in sales and profits growth.

A more recent analysis by Bain using data from the Great Recession reinforced that finding. The top 10% of companies in Bain’s analysis saw their earnings climb steadily throughout the period and continue to rise afterward. A third study, by McKinsey, found similar results.

The difference maker was preparation and execution. Among the companies that stagnated in the aftermath of the Great Recession, “few made contingency plans or thought through alternative scenarios,” according to the Bain report. “When the downturn hit, they switched to survival mode, making deep cuts and reacting defensively.”   Many of the companies that merely limp through a recession are slower to recover and never really catch up.

How should you guide your portfolio companies in advance of a recession and what moves should it make when one hits?  We’ve got some great tips and questions to challenge your leadership team:

OPERATIONAL EFFICIENCY IS A GAME OF INCHES

Companies that are even marginally better than their competition can steal market share in good times AND in bad times.  As we face recessionary pressure, it’s good to challenge your leadership team with two key questions:

How will we maintain a consistent flow of supply with tight labor markets and a volatile supply chain?

How will we tighten the belt during a slow period while optimizing our ability to serve customers and protect employees?

THE NEED FOR SPEED

Speed of execution is extremely important for business momentum.  The plan to achieve numbers cannot be with big cuts or to pause initiatives due to recessionary fears.  Our advice – proceed with caution and reframe initiatives as an investment with a clear ROI for each initiative.

The sooner a portfolio company can find and mine hidden value, the higher the ROI once it is ready for a sale.  Some challenging questions to pose:

As an organization, do we have self-paced obstacles that slow our pace down to needed improvements or identifying opportunities to create value?

Where can we gain scalability and speed?

In addition to budgeting operational improvements into the budget, can we also allocate “excess availability” within working capital lines of credit to ensure improvements can continue to happen if things get tight during the recession (if cash flow in the ordinary course of business is a problem)?

QUESTION DATA WITH FEEL

Coach Maddon told his players there is a healthy tension and balance between art and science, between data and winning strategy.  Sometimes as a leader you must go with your gut and instincts (while also evaluating data and performance). 

As a PE firm with multiple portfolio companies, perhaps 1 or 2 of the companies are hitting grand slams consistently.  Maybe a few companies are always striking out.  Perhaps a few of your companies are hitting singles and doubles, but you feel the potential is there.  We would recommend focusing operational improvements on companies hitting singles and doubles – turn those into triples and home runs.  These companies demonstrating positive performance (but still not quite there) could benefit from focus.

PHONE A FRIEND

Do you have one company in your portfolio that is already challenging your patience, mental capacity, and time? 

Do you want to get ahead of impending situations before they go from bad to worse? 

At The ProAction Group we do three things:

1. Conduct a Pre-Close Operational Diligence

• Like a QofE, but with a focus on Operations
• Quantify “how much more will you make when you run it right?”

2. Implement

• Drive initiatives to increase EBITDA and to improve your position in the market.
• Guide your management team to scalability.
• Get rid of the pain.

3. Revitalize Stale or Stagnate Portfolio Companies

• Do you have one portfolio company that requires more thought and effort than all the others combined?

Call us today so we can help you ensure your portfolio companies come out of the recession with winning returns.  There is no time to waste!