How do you quickly evaluate a company's distress?

Suppose a restaurant chain is seeing a decrease in customers. The management might first check their cash flow to see if they can keep the business running. If they find out that they're burning through their cash reserves quickly and might not have enough to pay off an upcoming loan, that's a red flag. To get more precise, they might make projections on their cash flow for the next year, considering various scenarios like "What if we cut down on advertising?" or "What if we introduce a new, cheaper menu?" Economic downturns could impact a company's cash flow. Companies should also look at other financial and operational metrics for a more holistic view of their health.

This is such an important consideration, yet so many founders/leaders look at it only when they’ve reached the end of the rope. Cash Flow is the lifeblood of an enterprise. One best practice I’ve seen is in educating and empowering leaders to improve their financial acumen and challenging them to practice strengthening their skills on a daily basis through operational rigor - reviews,regular checkpoints and financial deep dives.

Consider the case of Toys "R" Us, which declared bankruptcy in 2017. One of the key reasons for its failure was a massive amount of debt, roughly $5 billion. Despite being a well-known brand, the company couldn't generate enough cash to meet its debt obligations. Had one evaluated its debt structure, they would have noticed red flags like high interest rates and stringent repayment schedules that the company couldn't keep up with. A company's debt structure should be reorganized to alleviate distress. Debt restructuring or refinancing can sometimes provide a struggling company with breathing room. Not all debt is bad; strategic debt can help accelerate growth if managed wisely.

Think about Apple Inc. One of its major value drivers is its brand and customer loyalty. People buy Apple products because they trust the brand and like its ecosystem. This leads to high-profit margins and a great return on invested capital for Apple. But if Apple suddenly started to compromise on quality or innovation, that would erode its value, and we'd see that reflected in its financial numbers. Knowing which value driver has the most impact can help prioritize resources and strategies. Also, market conditions can change, and the importance of value drivers can shift over time. It's crucial for a company to continually reassess its value drivers in light of current market conditions.

Blockbuster Video serves as a cautionary tale. At one point, they could have chosen different strategic options, like transitioning to online streaming. But they failed to assess these options effectively, and instead, Netflix rose to the occasion. Blockbuster could've benefited from a detailed assessment of strategic options like diversifying, merging, or even fully transitioning to a digital platform. Selecting the right choice usually involves a cost-benefit analysis and risk assessment. Also, 'timing' is everything—some options might be feasible now but not later. There’s a lot of dynamic play between the market conditions, the company’s internal situation, and these strategic options.