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Preserving and Improving Liquidity During a Crisis

Maximizing the value of a business means focusing resources and energy on maximizing cash flows (improving liquidity) and managing risks.  In the age of COVID-19, this work has become more difficult for many businesses.  Companies are being forced to close, customers are pushing orders or payments, and supply chains are disrupted.  Liquidity has become a hot topic, as more and more companies struggle to preserve their cash.  So how can leaders preserve and even improve liquidity during a crisis?

In our view, the steps to preserving and improving liquidity are building (and using) an effective 13-week cash flow forecasting tool, using the model to identify levers that improve cash flow, using the model to communicate the plan to your stakeholders, pulling levers to improve cash flow, reviewing the model weekly, and continuing to communicate with your stakeholders.  We will explain each of these steps in greater detail below.

Build and utilize a forecasting tool to improve daily decision making and effectively communicate with internal and external stakeholders.

The best tool to use to improve liquidity and capital is a 13-week rolling cash flow forecasting model.  This model accomplishes three primary objectives.

    1. Predict cash flow and collateral, week over week, for the next 90 days.
    2. Allow for or improve decision making at the transaction level.
    3. Allow for or improve communication with key internal and external stakeholders.

A 13-week rolling cash flow forecast shows the details of anticipated cash receipts, cash disbursements, and changes in bank collateral through the forecast period.  Specifically:

Cash Receipts

Your company should forecast cash receipts from:

    • When current Accounts Receivable (AR) will be received.
    • When future revenues will convert to cash receipts.
    • Other non-operating cash receipts (e.g., interest income, proceeds from the disposition of assets, etc.).

Cash Disbursements

Your company should forecast cash disbursements from:

    • Current accounts payable (AP).
    • Future planned expenses*.
    • Other non-operating cash disbursements (e.g., debt service, un-funded capital expenditures, distributions, etc.).

*Future projected expenses can be derived from budgets and recent experience, but should also consider anticipated changes to your business as a result of COVID-19 (e.g., reducing production headcount or hours, renegotiating vendor terms, etc.).

Bank Collateral

The collateral component is often missed in 13-week rolling cash flow forecasting models and can lead to unanticipated liquidity challenges.  Cash receipts, cash disbursements, and other business activities can have an impact on the bank’s collateral and, therefore, the company’s liquidity.  A good 13-week cash flow forecasting model should take into consideration how changes in AR and inventory impact the bank’s collateral and, therefore, the line of credit.

Cash On Hand

Cash on Hand is calculated using the following formula:

Beginning Balance + Cash Received – Cash Disbursed +/- Changes in LOC

Miscellaneous

Here are a few other things that you should keep in mind as you build your model.

    • The cash flow should be rolled at least weekly. In times of crisis, you may want to roll it daily.
    • As a result, the model should be easy to create and update.
    • The model should be linked to your accounting system or allow for direct imports of data from the accounting system.
    • Have a weekly clean cut off, so you are working with the most relevant and timely data.
    • The model should be reviewed at least weekly by the leadership team.
    • Given the current COVID situation, it may make sense to expand the model to 52 weeks or longer.

A cash flow forecast is a beneficial tool to use when communicating with your stakeholders.  For example, if a customer asks to revise payment terms, you can make the modifications in the forecast to determine the impact on your liquidity before agreeing to the change. Additionally, if you are asking the bank for some form of relief, you will be able to show them how you determined what your need is, which will give them confidence in management tools and decision making.

Use the model to identify levers.

Once you ave a functioning model, it is time to use it to find ways to preserve or improve your cash position.  We call this “pulling levers” or taking actions that can improve cash flow.

Start by reviewing your income statement to find opportunities that will improve revenue or reduce expenses.  Next, look at your balance sheet.  The accounts on the balance sheet represent opportunities to accelerate cash receipts or slow cash disbursements.  The balance sheet accounts also represent multiple market relationships, every one of which represents an opportunity to renegotiate to improve cash position.

Additionally, consider “off balance sheet” items, such as an equity raise, or a loan from family and friends.  Many companies are applying for government loans, such as the Payroll Protection Program, or grants.  Consider what other sources of capital may exist for your business in your network.

Examples of levers can include:

Cash Receipts

    • Reducing payment terms with customers.
    • Require deposits for new customer orders.
    • Additional cash infusion from owners or investors.
    • Sale of unused or under-utilized assets and equipment.
    • SBA lending or other government assistance.
    • Negotiate increases in collateral advance rates or LOC limits.

Cash Disbursements

    • Negotiate new payment terms with vendors or negotiate payment plans.
    • Reduce direct material order quantities or push deliveries.
    • Reduction of labor (headcount or hours).
    • Renegotiation of contracts or agreements.
    • Deferral or reduction of rent and lease payments.
    • Negotiate deferral of principal or interest payments with the bank.

Communicate your plan to your stakeholders.

Once you have built useful forecasts and identified levers, it is time to communicate the plan to your stakeholders.  What do we mean when we say “stakeholders”?  We mean the Customers, Vendors, Employees, Owners or Investors, and Community that are a part of your business and share in the success of the business.

Remember that your stakeholders are an essential part of your business.  You want to make sure that they are aware of the company’s plans and its impact on them.

Make sure that the company has a primary point of contact for each stakeholder group.  For example, the CFO should be the primary point of contact for stakeholders like the bank, investors, and CPA firm.  This point of contact would be responsible for gathering needed and relevant information, communicating the company’s plan to stakeholders, and responding to questions from stakeholders.

When communicating your plan and any requests to your bank specifically, describe the following:

    • How did you develop the forecast?
    • What does the forecast show?
    • What steps are YOU taking to improve your liquidity and capital position?
    • What do you need from the bank (how much and for how long)?

Remember that your banker is having a lot of these conversations. Banks are under a lot of stress too. Bring a plan to your bank, don’t expect them to give you one.

This holds for all your stakeholders.  Your customers and your vendors are probably going through the same exercise as you.  Make sure you are clear and considerate in your communication.  Look for win-win solutions. 

Start pulling levers.

Once you have your plan in place and have communicated it to your company’s stakeholders, it is time to start pulling levers.  Make sure that you develop an action list for the levers you are going to pull, including an owner for each action and a due date.  Review this action list on a weekly, if not daily basis.

It is also essential to ensure you are updating your model as you pull the levers.  If you request a customer pay in 15 days and they agree to 25 days, make sure the cash flow forecast reflects that change correctly. 

Review the model weekly and communicate with stakeholders.

Once you have created the forecast, identified levers, communicated the plan to stakeholders, and started pulling levers, it is crucial to maintain this rhythm.  Update the forecast weekly and review the forecast as a team.  Look for changes in the forecast and review the weekly variance report.  This will help you improve the accuracy of the model.

Also, your team should be looking for new levers on a weekly basis.  This is not a one-time event!

This also applies to communication with your stakeholders.  In a time of crisis, the amount of communication with key customers, key vendors, employees, the bank, and ownership should increase.  Continue to update your stakeholders on your plan and progress against the plan.

Closing

The COVID-19 crisis has brought numerous challenges to business owners, and leaders, including preserving liquidity.  Taking the steps above will help, but they aren’t always easy.  If you are struggling with any of the steps listed above or would simply like to talk, please reach out.  At DWH, we’re here for you, even remotely.

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