Managing Cash Flow in Times of Uncertainty

The unprecedented events in response to the COVID-19 pandemic are impacting every business in complex ways. Maintaining adequate cash flow to sustain successful operations is likely to elevate as a significant risk for many companies. However, there are tried-and-true processes that can help identify a potential cash crunch and maximize critical reaction time to avoid or minimize business interruption.

Focus on Cash Flow as Opposed to Net Income

Just as it is possible for unprofitable companies to generate positive cash flow, it is possible for profitable companies to face cash shortfalls. Notwithstanding events like a sudden loss of revenue, companies that have experienced high levels of growth typically have funded their increasing working capital needs through external financing whose obligations must be met. If you are used to managing based on an income statement, now is the time to focus on liquidity by examining your short-term cash flows. Profitability becomes irrelevant if you run out of cash.

Assemble a 13-Week Cash Flow Projection

A 13-week cash flow projection (or one calendar quarter) allows management and other users to pinpoint the major short-term sources and uses of company cash and to gauge the relative size and timing of potential cash shortfalls. Unlike GAAP-based financial statements, a 13-week cash flow is simply “cash in, cash out,” similar to your personal checkbook register. To gain a better understanding of your company’s cash flow picture:

• Assemble a series of actual weekly cash flows to identify patterns and trends.
• Identify and forecast the total cash sources throughout the 13-week period, like collections of existing receivables and cash receipts from subsequent sales.
• Establish your relevant cash disbursement line items such as payroll, payroll taxes, employee benefits, vendor payments, insurance, rent, professional fees, other tax payments, capital expenditures, debt service payments, and any other contractual obligations.
• Assign each payment to the appropriate week. To compute weekly net cash flow, subtract each week’s disbursements from the cash sources. Roll the cash balance cumulatively from one week to the next, identifying any periods where the cash balance reflects a deficit.

A comprehensive model will also incorporate a revolving line of credit as well as projected collateral balances like receivables and inventory to ensure that the short-term collateral can support the required line of credit balance. Building from metrics like days sales outstanding, days payable, and inventory turns aids the preparer in assembling a defensible cash flow projection.

Remember, it is more important to develop “reasonable assumptions” than to try to make the forecast perfect. Draft all assumptions, which should be clearly summarized, concise, and based on expected operating conditions.

Benefits of the 13-Week Cash Flow Projection

The following are several tangible benefits of a 13-week cash flow projection:

• It opens dialogue among the management team and allows the opportunity for agreement or disagreement on the key assumptions driving the projected cash flows. How big is the cushion of solvency? Does pricing need to be adjusted in the short term to salvage customers? How have your competitors reacted to the current environment?
• The process distinguishes the most critical relationships to the company among employees, customers, and vendors. Management will frequently establish a hierarchy of the essential versus non-essential payees.
• It helps identify potential periods of illiquidity, allowing management crucial time to react or explore financing alternatives. The exercise also identifies fixed versus variable expenses. You can also build scenarios from the model and “stress test” it against various conditions.
• It can expedite crucial communications within your company or with your lender, creditors, investors, and external advisors. It can also aid in negotiations – lessors and vendors have a vested interest in your survival.
• Tracking actual weekly cash flow activity compared to a projection helps identify cash flow variances, improves decision-making, and allows for better ongoing assumptions.
• If you miss a payment to your bank or break a covenant, your lender may request a period of forbearance subject to certain conditions. Oftentimes, one of the forbearance terms entails providing a 13-week cash flow projection and actual weekly cash flow reporting thereafter.

Considerations for a Possible Cash Shortfall

If the model shows a lack of cash or borrowing capacity in a given week, you have a problem to solve. If the gap is moderate, consider these ways to increase short-term liquidity:

• Offer a discount to customers for accelerated payments.
• Prioritize payments to critical vendors or commit to terms of Cash on Delivery for new purchases.
• Exhaust opportunities to raise debt or equity capital from existing shareholders.
• Sell excess or non-essential assets.
• If you own real estate, evaluate a sale-leaseback.
• Request temporary rent abatement from your landlord and lessors.
• Evaluate SBA lending programs or alternative financing through asset-based lenders.
• Defer capital expenditures, especially if they do not serve your core mission.
• Monetize slow-moving or obsolete inventory by offering it to customers for a discount or sell it for scrap value if necessary.

If the cash flow gap appears overwhelming, you may need to explore dramatic changes to your business model or plan for significant changes to your capital structure. If it becomes clear that your debts cannot be serviced and must be restructured, it may be wise to conserve cash for retainers to legal and consulting advisors to explore a Chapter 11 reorganization. Have copies of your loan agreements on hand so the contractual rights of the lender can be evaluated by your advisors.

Navigate Beyond the 13-Week Period

Once you have established comfort in your short-term liquidity, take a longer-term view by building monthly projections and ultimately a multi-year business plan. Remember, disruptions must be navigated thoughtfully but they are usually temporary. This too shall pass!

Need Guidance?

As a part of the Katz, Sapper & Miller network, we have access to more than 350 tax and accounting professionals who can assist you with cash flow modeling, navigating the SBA loan programs, and evaluating tax implications and employee benefit considerations that come from this time of uncertainty. Contact us today to discuss your situation.