Cashflow is the oxygen of a business; too little and the business risks failure, too much and it risks complacency leaving it exposed to new entrants and upstarts. When faced with an economic crisis, a business enters not with the resources they need, but with the resources they have. These resources represent the seeds by which business leaders must seek to protect and grow.

In a recent survey of MorganFranklin’s May 26, 2020 webinar on Liquidity, Business & Financial Reporting Considerations in the COVID-19 Era, over 60% of attendees expressed concerns over their liquidity and cash management (note: participants could choose more than one response).

what concerns do you have coming out of this season-liquidity-blog

During periods of financial distress, a business’ focus moves from increasing revenue and profits to cash preservation and liquidity. Previous budget and rulebooks are thrown out the window and the spotlight focus shifts to managing liquidity in order to survive the crisis.

Knowing not only what cash you have but also what cash your business will need in the short, intermediate, and long-term is the cornerstone to any successful business. To be effective, a credible cash flow forecast during times of unpresented uncertainty MUST be updated frequently as information becomes available so that new and informed decisions can be made.

Today, a cashflow forecast should have assumptions around the effects the pandemic will have on a business’ current and future liquidity needs, as well as when and what a return to normal operations may entail.  Assumptions are in constant flux and require rapid modification, frequently requiring the deployment of tactics that would be radical in ordinary times. Decisions made during times of financial distress may be very costly, have long-tail residual effects, and/or hamper future growth, but they are done simply to survive.

Although the COVID-19 pandemic is proving to be a particularly difficult storm for businesses to weather, this is not the first (nor the last) crisis that will affect most businesses.

Addressing Immediate Liquidity Needs

If you find your business in financial distress, don’t panic and take control. First, prioritize your cash expenses starting at the top with “needs”—expenses you must pay to deliver your product or service to customers and the “optional”—expenses that are not critical to day-to-day operations. In creating the prioritized list, below are some key actions that you may choose to take to stop the cash bleeding and buy time for a recovery.

Operational Initiatives:

  • Delay planned capital expenditures
  • Reduce inventory levels
  • Extend payables for non-critical suppliers.
  • Accelerate collections from customers
  • Initiate layoffs or delayed hiring and implement employee benefit cost reductions
  • Perform asset sales (physical assets as well as monetary
  • Increase attention on internal controls to prevent fraud
  • Seek rent abatement for any property that is leased and not being used

Capital Initiatives:

  • Cease all cash outflows to investors/owners
  • Pull-down unused capacity from bank lines of credit and/or request an over-advance.
  • Sale of receivables (e.g., factoring, securitizing)
  • If the business has term loans and you know it will not meet an upcoming debt covenant, alert the lender early and ask for a waiver
  • Shift in debt capital structure, for example re-balancing outstanding loans to/or from a fixed or variable rate or converting cashflow loans to ABL loans
  • Issuance of new term or convertible debt and/or equity infusion

The Rule of 3 Scenarios

Once you clearly understand the cashflow you have and you have taken measures to tightly control it moving forward, you should shift your focus to the future. What does that future look like? Right now, many states are beginning to re-open their economies, but there are significant restrictions on how businesses can operate and at what capacity. How do you think things will play out in your areas of operation?  To answer these and other questions you need to create a cashflow forecast.

You should begin with creating at least three scenarios: a best case, worst case, and base case (most likely). For every scenario, create a list of assumptions that will be applied throughout the forecast horizon. Each scenario will have different assumptions for the unknown future variables that are being estimated. Each scenario must include the following:

  • Multiple time scales: the now, the next, and the later
  • A list of all future events and uncertainties that could potentially impact your business
  • Develop contingency plans for each scenario: What happens if you don’t hit it? What’s next?
  • Define leading indicators for each scenario that inform actions

Your cashflow forecast should inform you on the business’s cash burn rate. The cash burn rate can be calculated in two ways:

  • Gross Cash Burn Rate: The total amount of cash a business is spending per month. This should be calculated on a weekly and monthly basis.
  • Net Cash Burn Rate: The net difference between cash in and cash out per period. If the number is positive, you’re not burning cash, you’re building cash!

For summary purposes, you can sum both metrics over your forecast horizon and then divide by the number of periods (e.g., number of weeks in the forecast or months in the forecast). Take each metric (Gross Cash Burn Rate, and Net Cash Burn Rate) and divide them by the company’s current cash balance, respectively. This is how long, in number of periods, the company has to survive and is also the amount of time management has to effectuate a turnaround or restructuring.

Best Practices

During times of stress, people tend to freeze up causing action paralysis. This inaction is almost always the worse reaction. Creating scenarios helps to plan out the steps that need to be taken ahead of time, given certain events.

  • Your cashflow forecast should be at least a 13-week forecast
  • Don’t fall in love with your Base Case cashflow forecast. Remember the old proverb, “Plans are worthless, but planning is everything.”
  • Continuously monitor your economic environment for changes
  • Have a contingency plan. Sometimes the best laid plans don’t work

Authored by: Ken Fick and Tom Roland

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