From time to time, all businesses experience surprise disruptions.
These may be events that are common to all of us, such as the Great Recession or today’s Coronavirus. Or, they may be more specific to a set of circumstances, whether those are geographic (e.g., hurricanes, tornados), industry-related, or affecting a select group of companies, in the case of product recalls, strikes, unique supply chain problems and so forth.
Whatever the specifics,
there is only so much a business can do to be prepared for such situations. And, because these events are usually unpredictable — at least as it relates to timing — it is easy to waste resources being
But once the crisis is near or here, what should a business do? The short answer? A lot. This newsletter focuses on the financial piece.
Let’s consider each…
Look Ahead Financially
, I talked about the need to look ahead and do your best to understand what upcoming trends may mean, financially, for your company. In doing so, profits, the balance sheet and cash flow are projected for 12 to 36 months, given a set of business assumptions.
When faced with
disruptions, use these same tools to run “what if” scenarios — lower sales, customers taking longer to pay and so forth.
My suggestions still hold in the face of our current crisis: schedule the time, stay out of the weeds, look externally, apply common sense and keep a close eye on cash flow and the balance sheet.
In particular, focus on those last two: cash flow and the balance sheet. Make sure to project loan covenants and know under what scenarios your company will be in default of those covenants.
For example, if you must report a borrowing base (usually on accounts receivable and inventory), what happens if there is a spike in ineligible receivables? Typically, a customer is ineligible if an invoice is more than 90 days either past due or beyond the invoice date, depending on your loan agreement. That might reduce the amount you can borrow.
Also, look at the date your loan expires, and then must either be repaid or renewed. If that occurs within the look ahead time frame, model what happens if the lender reduces the credit line for the same reasons above. Also, if your industry is in a downturn, your machinery and equipment are worth less and that means less collateral value for the lender.
Besides looking at loan agreements, look at other business agreements that require certain performance. For example, in the early 90’s when I was in the rent a car business, we routinely projected airport fees as the percentage of revenue called for in the contract. But when the Gulf War got underway and sales dived, we had to take into account the
minimum payments to the airports.
don’t inadvertently plug cash in your projections.
This happens when you project cash flow using the GAAP cash flow statement method (formerly and more appropriately called “sources and uses of funds”). That method works for
numbers but not for projected numbers. Instead, project cash flow directly, as I explained
Manage Liquidity With a 13-Week Cash Flow Projection
Cash is always king.
Even more so when your company is under stress.
The key tool for managing it is the 13-week rolling cash flow, as I explained
Make sure to update the forecast weekly, after you have the prior week’s actual cash receipts, disbursements, and purchases and shipments of inventory items and product. Make reviewing the projection part of your weekly management routine.
The projection is not that hard to do:
A former client of mine was in the high-end party rental business and we had to update the cash flow weekly, not only to survive, but to comply with the lender’s terms. Every Monday, we started with cash in the bank and the opening accounts receivable balance. Then we forecast weekly sales, which increased accounts receivables. Next, we forecast collections, which brought in cash and reduced accounts receivable. After that we forecast the disbursement of normal operating expenses, such as payroll, delivery truck rental fees, detergent to clean dishes and linens (a big expense for the industry in peak party time) and more. After layering in debt service and projected cash infusions, we had ending cash.
For the early weeks in the forecast, we used what was in accounts payable to project operating expense disbursements and actual open invoices to project collection. Open orders were the basis for near term sales. The out weeks were based on trends and history. We moved payments around to stay solvent.
We were able to project when and how much of a cash infusion would be needed based on this projection. There was no need to project inventory in this situation, but manufacturers, retailers, distributors, and anyone else with significant inventory, must.
refers to potential events with measurable frequency and, therefore, predictability.
events, on the other hand, are those whose frequency can’t realistically be measured, and which are therefore inherently unpredictable.
For example, we know epidemics and pandemics happen, but we can’t predict the timing. Likewise, with business crises, while we know bad things might happen, we don’t know if, when or how bad. So, when doing the look ahead projections, don’t get carried away with attempts at precision. And remember, you definitely cannot predict the odds of something happening.
don’t just look at potential declines in revenue or customer nonpayment. Also consider potential disruptions in supply chain, access to employees, access to facilities, and other occurrences which can have a critical negative impact.
A Sad, But True Story
Earlier this week, I caught up with a friend.
In the past, he was a roving CEO of sorts for a large, prominent, private equity firm known for special situation investing. There and subsequent to that he has developed expertise in distribution businesses. Today, he sits on the Board of a specialty distributor owned by a private equity firm. To “gain scale” that company bought a similar company that serves a different marketplace, both in terms of product and geography.
At his first Board meeting, my friend asked to see the 13-week cash flow. He was told, “We don’t do that because we don’t need to. We don’t invest in the kinds of companies your old firm did.” Then he asked about financial projections that show the combined firm. Here he was told, “Management, particularly the CFO, is too busy with the integration efforts to do that.”
To the Board’s surprise (but not my friend’s),
the company defaulted on loan covenants this past November. In December, it entered into a forbearance agreement with its lender, where the lender agreed not to foreclose for a period of time, provided the company met certain conditions, including certain cash or revolver availability numbers.
In February, the company defaulted again. Why? Because it can’t forecast cash flow and it had no chance of making the projection that was in the December forbearance agreement.
Don’t let this happen to your business!
Disruptions are a part of business, some more severe and unpredictable than others. And while you may not be able to control the timing and intensity of unwelcome events, you can weather most of these through a timely dose of planning and a focus on the critical elements of your financial health.