When it comes to maximizing the value of your business, it’s best to focus resources and energy on improving cash flows and managing risks. The last two years have brought a number of unique challenges to business leaders and liquidity has become a significant topic. Companies are having to make major decisions that will potentially impact cash flows. So how can leaders address this?

Step 1: Develop a Cash Flow Forecasting Tool

When it comes to best practices around preserving and improving liquidity, we like to suggest one approach that has proven to be effective among many of our clients – and that is to develop a robust 13-Week Cash Flow Forecasting Tool. This financial tool helps businesses accomplish three primary objectives:

• 1. It predicts cash flow and collateral, week over week, for the next 90 days.
  2. It improves decision-making at the transaction level.
  3. It improves communication with key internal and external stakeholders.

An effective 13-Week Cash Flow Forecasting Model also 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, draws on a line of credit, 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 (e.g., new program launches, wage increases, new hires, etc.).
• • Bank Collateral – the collateral component is often missed in 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 (LOC) availability.
• • 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.

Step 2: Use the Model to Identify Levers

Once you have a functioning model, it is time to use it to find ways to preserve or improve your cash position. We call this process “pulling levers”. Reviewing your income statement will allow you to find opportunities that will improve revenue or reduce expenses. After, you’ll want to 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. 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.
    • The 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.

Step 3: Communicate with Stakeholders

Once you’ve built useful forecasts and identified levers, it’s time to communicate the plan to your stakeholders (think customers, vendors, employees, owners, investors, and community members as needed. Remember, your stakeholders are an essential part of your business and share in its success. When communicating your plan to your bank, describe the following:

• How you developed your cash flow forecast
• What your forecast shows
• What steps you’re taking to improve your liquidity and capital position
• What your current needs are and how might the bank be able to help

It’s better to bring a plan to your bank than to expect them to give you one. This holds for all your stakeholders. Make sure you are clear and considerate in your communication, looking for win-win solutions. You’ll gain confidence from your banking institution by showing exactly how you’ve determined your needs through management tools and decision-making.

This tool is also beneficial for the purpose of discovering the expectations of your customers as well. For instance, 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.

Step 4: Start Pulling Levers

Once you have your cash flow model 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 a point person for each action and a due date. Review this action list on a weekly 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.

Step 5: Review the Model Weekly and Continue Communication 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 consistently review 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. Additionally, your team should be looking for new levers on a weekly basis. It’s also important to note that in times of distress, the amount of communication with key customers, vendors, employees, financial institutions, and ownership should increase. Continue to update your stakeholders on your plan and your progress.

 

If you found this topic interesting, our strategic partner, JACO Advisory Group published content you may find relevant as well: Navigating Unexpected Business Disruptions by Preserving Liquidity

If you’re wanting to learn more about our cash flow forecasting model or would simply like to talk, please reach out. At DWH, we’re here for you — even remotely.