From time to time every CPA has the opportunity to play a vital role in assisting a client to achieve a successful turnaround. The ability to recognize the need and respond accordingly can make the difference between preserving a valued client and losing on two accounts: first when the client declares bankruptcy, and subsequently when the auditor is sued.

The reasons that companies get into trouble are numerous and varied. A list of some of the early warning signals of trouble is displayed in Exhibit 1. If the accountant relies on the client to ask for help, he may not be brought into the matter until it is too late. Clients are often reluctant to initiate a discussion with their accountant regarding financial difficulties because:

* The client is uncomfortable discussing the problem, or unwilling or unable to recognize it;

* It may impair the ability of the client to obtain an unqualified opinion;

* The accountant has been a trade creditor who, recognizing the problem, may (and should) demand more stringent payment terms;

* Perceived audit risk could induce the accountant to resign from the audit or expand the audit scope and fees;

* The accountant is often relied upon to provide references to third parties as to the quality of the business and/or management;

* Cash constraints may cause the client to believe that he cannot afford outside assistance; and

* Management may be unaware of the ability of the accountant to be helpful in a turnaround.

Breaking down these barriers eliminates obstacles to constructive action. Each of these issues is an appropriate matter of concern that cannot be ignored. They should be appropriately addressed, with the focus, however, being on actions required to achieve the larger and more important goal of turning around the company.

Why the Accountant is a Key Player

The accountant has the potential to emerge as a key participant in any turnaround program. Sensitivity to the need for a turnaround program begins with the accountant's recognition of the financial deterioration of the business. The accountant is often the first to spot the signs as they begin to reveal themselves in the company's financial performance. The accountant is also more likely to be objective in recognizing the problem, since he is neither the confident salesman nor the new product visionary. He is more inclined to use the numbers as unbiased arbiters of performance.

The accountant's facility with finances make him a more vital player in a turnaround than during more prosperous times. The ability to see through the financial implications of alternative plans of action, and to interpret their financial consequences enhances the role of an accountant in turnarounds. He must provide the basis for allocating scarce financial and managerial resources. Most successful turnaround specialists are skilled in accounting. It would be a reasonable characterization to state that visionaries build companies despite accountants, yet accountants help salvage companies despite visionaries.

The independence, objectivity and broad range of experience that many accountants bring to turnarounds is a reason that creditors and other third parties frequently demand their involvement. The accountant may be the company's auditor, or he may be one of the growing legion of specialists practicing specifically in the area of turnarounds. As an outsider, he is usually not wedded to the decisions that contributed to the company's financial distress. Instead, he has the potential to be part of the solution.

Stages of a Turnaround

The symptoms of financial distress seldom surface overnight, nor are they generally susceptible to immediate correction. The conditions preceding a financial crisis are usually the cumulative result of an extended period of business and financial deterioration. If the problem had been easy to remedy, it would already have been solved by management. "Quick fixes" seldom produce permanent results. Management's most urgent plea to "get more money" is not the solution. In the absence of a cogent plan, more money merely adds fuel to the fire by increasing debt, diluting ownership, and placing additional restrictions on collateral and operating flexibility. Imprudent use of borrowing capacity can dig a hole so deep that a company will never get out.

A successful turnaround requires a significant sustained effort on the part of management and professionals. The atmosphere surrounding their efforts generally has three distinct stages: crisis, stabilization and rebuilding. The focus and relevant time horizon of activities during each phase will vary.

During a crisis cash is king. The focus of activities is normally on how to conserve cash and how to get cash. As the crisis subsides, the emphasis switches to placing the company on a more solid foundation. Major activities may include recapitalizing the company and eliminating unprofitable operations. However, neither of these activities results in a turnaround. At best, they buy more time, and enable the company to survive. A true turnaround is achieved once a company is in a condition to not only survive, but thrive.

The Crisis Accountant

The catalyst that induces the accountant's involvement in a turnaround may be the insistence by the bank or other creditors for credible numbers, or a demand that the company get independent assistance. At this stage management has often lost credibility. The accountant may be imposed upon the company to placate skeptical or dissatisfied creditors. The ability to become a vital contributor to the turnaround process rather than an attendant cost depends upon providing service that is relevant, timely and well founded.

In the midst of a financial crisis, services must be focused on solutions that will have an immediate beneficial impact upon cash. Developing five-year business plans or management information systems is not meaningful if the client may not survive to see their implementation. At this stage the focus must be on action rather than studies, and on providing direction rather than waiting for a request to provide assistance.

Most clients and many accountants are in unfamiliar territory when it comes to acting decisively in a financial crisis. A crisis may deteriorate quickly if the players are paralyzed into inaction. The accountant has an opportunity to assume a leadership role in:

* Prioritizing tasks and monitoring their implementation during the crisis;

* Imposing a program to control and limit all disbursements;

* Seeking interim financing;

* Recommending and evaluating professionals such as bankruptcy counsel, crisis management experts, liquidators and/or investment bankers;

* Communicating with creditors to exact concessions and enlist their cooperation;

* Identifying cash drains that can be curtailed immediately;

* Projecting the near-term (four to eight weeks) sources and uses of cash;

* Identifying surplus assets that can be sold and non-vital leased assets;

* Working with bankruptcy counsel to evaluate strategic alternatives;

* Clarifying the capital and debt structure, including terms, restrictions, credit availability and unleveraged assets;

* Developing strategies that will liquify assets (e.g. sale/ leasebacks, collecting interest on deposits);

* Consolidating bank accounts to facilitate access to cash;

* Accelerating refunds of income taxes paid in prior periods that may be refundable as a result of current losses;

* Simplifying management information systems to provide prompt financial information focusing on cash; and

* Imposing internal controls to alleviate an out-of-control situation.

In the midst of a financial crisis, the distinction between an independent accountant and a member of the management team may become less clear. Many of the enumerated activities are reasonably similar, whether the accountant is an employee or an outsider. The independent accountant must often pitch in to assist an understaffed client. If the independent accountant is also the company's independent auditor, care must be taken to avoid conflicts with the independence standards contained in the AICPA's Code of Professional Conduct. The independent auditor may have to choose between preserving his independence and intervening more directly on behalf of a client, which may jeopardize that independence and mandate resigning as auditor. Companies don't like to change auditors in the midst of a financial crisis, nor do auditors care to surrender the ongoing relationship of a long-term audit and tax client. To resolve this potential conflict and because of the specialized skills required, crisis accountants are frequently drawn from sources other than the company's auditing firm.

Restoring Order

Assisting a client in weathering a financial storm does not ensure survival, it merely helps to buy time. The seeds for a successful turnaround are normally sown during a period of stabilization, when well contemplated intermediate-and long-term strategies replace stopgap measures. The accountant who was a successful member of the crisis team is probably an indispensable member of the team formed to stabilize the company. The accountant just coming on board at this stage has no less crucial a role, provided that he or she has the ability to quickly assess the situation and gain the confidence of the key participants in the turnaround.

The goal during the period termed as "stabilization" is to ensure that stability is in fact restored. The line of demarcation between crisis and stabilization is not well defined. A company in fragile financial condition can quickly relapse into a renewed financial crisis. The main criterion for evaluating whether a company is "out of the woods" is determining whether it has sufficient capital to withstand the inevitable peaks and valleys and negative variances that all businesses face.

The foundation for a successful turnaround is a detailed business plan that reflects the collective judgment and knowledge of management and its professional advisers. The most important aspect of preparing the business plan is the systematic process through which all significant aspects of the company and its operations are objectively analyzed to determine an optimal operating and capital structure to effect the turnaround. Some of the key tasks that the accountant may perform when pursuing this endeavor include:

* Preparing the business plan document;

* Preparing a detailed set of financial projections covering a minimum of twelve months, and then four quarters, and three subsequent years;

* Performing a diagnostic review or operational audit;

* Analyzing the cost structures of various products and lines of business;

* Developing financial reporting and internal control systems;

* Valuing the company, its subsidiaries and/or key product lines on a going-concern and liquidation basis;

* Analyzing the negotiating positions of key creditors;

* Recruiting new members of management;

* Preparing various financial schedules;

* Providing specialized audits; and

* Ensuring that any recapitalization transactions are consummated with a view to preserving the benefits of any net operating loss carryforwards that are in place.

Each of these activities will be supportive of concurrent efforts to raise capital, restructure debt, sell assets, eliminate unprofitable products and lines of business, enhance asset utilization, and reduce the cost structure of the business. The accountant may lead these efforts or provide data to support them. Besides being cognizant of his independence, the accountant must also be familiar with the ACIPA's Statements on Standards for Attestation Engagements and the Statement on Standards for Accountants' Services on Prospective Financial Information.

Rebuilding the Business

The rehabilitative stage of a turnaround begins as the revitalized core business, devoid of damaging segments, is used as the foundation for initiating a program to achieve genuine growth in revenues and profits. Absent sustained meaningful improvements in both of these areas, a true turnaround cannot be said to have been accomplished.

Stopping losses by cutting expenses and eliminating unprofitable activities is normally easier to achieve than implementing revenue growth strategies. The latter activity challenges the skills of most managers and accountants. Growth strategies are normally achieved by:

* Increasing prices;

* Improving market penetration;

* Introducing new products and services;

* Expanding geographically; and/or

* Consummating acquisitions or joint ventures.

Growth strategies normally emanate from within the organization, and depend upon a conducive environment for attaining well-contemplated growth. Fundamental ingredients may include:

* Improving planning practices;

* Recruiting capable managers;

* Enlisting the support and cooperation of all employees;

* Establishing employee incentive programs;

* Developing marketing and sales strategies;

* Maintaining product and service quality;

* Training employees;

* Executing a capital expenditure program; and

* Gaining access to sufficient working capital to support sales growth.

The degree to which the accountant is involved at this stage depends upon his skills as a management consultant and a business adviser. At a minimum, the accountant should attempt to be sufficiently involved in all activities to ensure that they are executed with adequate planning and attention to financial implications to avoid a recurrence of a financial crisis. Discrete tasks that the accountant may perform include:

* Developing business plans and financial projections;

* Establishing criteria and systems to monitor performance;

* Tax planning; and

* Assisting in mergers and acquisitions.

The activities that the accountant engages in during the period that growth plans are successfully implemented gradually begin to resemble the normal range of client activities. The distinction is that, having survived the war along with the client, the accountant is probably now a more indispensable member of the team.

Assisting Third Parties

Accountants are frequently engaged by third parties to assist in turnarounds. They may work for creditors to represent their interests in monitoring performance, or they may work for the distressed company and be paid by creditors to enhance the likelihood of creditors being repaid. The customers of financially troubled companies have also been known to engage accountants and turnaround specialists to assist in a turnaround in order to ensure that vital goods are produced and shipped.

The role of the accountant may range from reporting the state of the debtor's financial and operating condition, to taking an active role in effectuating a turnaround. In such cases, the accountant must take care to ensure that the scope of services is understood and agreed to by all parties. Sensitivity is also required in cases where the accountant's actions could be construed as an attempt by the lender to run the business of the debtor, which could result in a lawsuit against the lender. However, the engagement can be properly conducted without exposing the lender to risk of liability, while also achieving the more important end of enabling the lender to be repaid.

Third parties may also engage the accountant to assess the likelihood of a turnaround for the purpose of lending money, providing credit, determining the advisability of conducting business with a distressed company, or evaluating the company as an acquisition candidate.

Accountant's Role in Bankruptcies

Bankruptcies tend to require substantial involvement on the part of accountants. In large bankruptcies, it is not unusual to have separate accounting firms representing one or more banks, various classes of creditors, the debtor and shareholders. The accountant may also serve as a trustee or an examiner.

The accountant working for the debtor tends to be directly involved in planning and implementing the turnaround. He is often a key interface with creditors, and may appear in the bankruptcy court as an expert witness. Bankruptcy-specific tasks such as identifying executory contracts that may be rejected or refundable preference payments may be initial activities. He may also be involved in preparing documents that are submitted to the bankruptcy court or to creditors, such as the following:

* Schedules of assets and liabilities;

* Schedule of current income and current expenditures;

* Statement of financial affairs;

* List of creditors holding 20 largest unsecured claims;

* Schedules and projections requested by creditors and/ or ordered by the bankruptcy court; and

* Schedules, projections and other data included in the disclosure statement used by creditors and shareholders to vote on a plan of reorganization.

Accountants working for creditors and shareholders focus their efforts on two areas: 1) investigating and monitoring the activities of the debtor; and 2) providing guidance to the constituency that they represent as to the information that must be understood to respond to various issues that may arise (such as the sale of certain assets or the use by the debtor of collateral to obtain credit). In cases where the debtor is poorly advised, the accountant working for other constituencies may be an effective force in guiding the debtor to undertake actions that are in the best interests of all parties to the bankruptcy.

An examiner may be appointed by the bankruptcy court to investigate whether management is incompetent, or guilty of fraud. Should either prove to be the case, or if management resigns, or if the bankruptcy case is converted to a liquidation in Chapter 11 or Chapter 7, a trustee may be appointed to operate or liquidate the company.

Practicing within the realm of bankruptcy is prescribed by Bankruptcy Code and the Bankruptcy Rules. Familarity with both is important to practicing effectively and professionally.

Getting Paid

Although practicing in the area of turnarounds can be exciting and gratifying, it can also be nonremunerative if the accountant fails to take adequate measures to ensure that he is paid. There is invariably a shortage of cash in any turnaround situation, and if the accountant isn't careful, he or she could become another unsecured creditor in a bankruptcy proceeding.

The best practice is to require payment in advance of, or contemporaneous with, providing services. Although clients may initially resist such a request, they will comply if they understand the importance of the services that the accountant can render. The value of good turnaround services should exceed its cost. The resultant cash flow enhancement and improved dialogue with creditors and other prospective sources of capital should justify the expense.

If cash is simply not currently available, the accountant should determine whether it will be available prospectively and obtain a clear agreement as to future payment. Sometimes shareholders may pay the accountant from their personal funds, or creditors may pay the accountant to work on behalf of the debtor. In some cases the accountant has no choice but to opt between accepting the calculated risk of not getting paid and a decision to simply not work on a project.

Working for a creditor may be less risky than working for the debtor, assuming that the creditor is creditworthy, and will pay the fees directly, rather than turning the bill over to the debtor for payment.

In a bankruptcy proceeding, the bankruptcy court must approve the retention and ultimate payment of accountants working for the debtor or any other parties seeking reimbursement for the accountant's services. For this reason, the accountant should not begin to provide service in a bankruptcy proceeding until the nature of his services and ultimate means of payments are quite clear. In providing for progress payments, the bankruptcy court often requires a 25% holdback that is not paid until the end of the bankruptcy proceeding. Sometimes nothing is paid until the end of the bankruptcy proceeding, or until there are available funds to disburse. If the company is liquidated, and the proceeds are insufficient to pay secured creditors, the accountant may wind up as another unpaid creditor. Where immediate service is required and the accountant has no reason to believe that the court will reject his retention, it is possible to begin work and gain retroactive court approval through a nunc pro tunc order.

Conclusion

The training of the accountant in assessing the financial implications of alternative courses of action, working with multiple constituencies, establishing systems and controls, and behaving in a responsible and credible manner, prepares him to play a critical role in turnarounds. Since most companies periodically go through stages of financial decline, the opportunity to be a key contributor to a rehabilitative and constructive process is always present. Recognizing the opportunity to be of service and responding appropriately and knowledgeably can avail clients of a service for which the accountant is ideally qualified and, if successful, for which he or she will earn the clients' unending gratitude. Exhibit 1 Omitted