Flying On Sight – leadership under heavy cash constraints

Cash constraints and scarce liquidity are notorious in Distress and Turnaround situations and often characterize situations of rapid change for many companies. Maneuvering under these conditions is often a question of discipline and applying the right tools in a timely manner. Challenges are faced on many levels of the organization, but ultimately it comes down to the simple question: Is the firm able to pay for its most critical liabilities?!

The answer to this is digital. If the answer is “yes”, the management has more time, to restructure and revitalize the business, if “no”, the firm is most likely to be liquidated. Either by the management or by debt owners, from the outside.

Leadership and management in Situations of Rapid Change

Mastering situations of turmoil and distress is depending on balancing the interests of various stakeholders. Distribution of funds to (selected) creditors, without taking the risk of supply chain disruption or suppliers and debt owners taking legal actions, keeping morale and engagement high among employees, and retaining trust and confidence with customers, banks and shareholders are vital. Close alignment and regular communication with key stakeholders is key. This includes lenders, shareholders, employees, suppliers (incl. landlords), customers, (tax-)authorities, governmental agencies, etc..

From a legal perspective, instruments like Chapter 11 under US legislation (or similar instruments that are available under other jurisdictions), may offer protection against outside liquidation. This is buying time for the management to restructure and revitalize the firm.

The management’s focus must be on preserving liquidity to maneuver through the situation of rapid change.

Surviving the next 4 weeks of cash constraints

Under distress conditions, executives face an accelerating dynamic of events. Staying ahead of these and controlling the pace of events, is critical to keep a company alive.

If survival is at stake, cash flow is key.

Top 10 for Cash flow forecasting & cash management

  1. plan cash flow 13 weeks ahead
  2. perform daily review cash flow for the upcoming 4 weeks
  3. assign only one person (CFO / CEO) to authorize payments
  4. create a triage of creditors. Who is critical to continue operations? Who can / is likely to create severe legal risks?
  5. act within the triage and match payments to receipts: find agreements for deferred payments, deliver partial payments, lengthen payment terms, if necessary, default on selected invoices, and utilize the latency of collection processes.
  6. stop all discretionary spendings
  7. postpone CAPEX
  8. reduce contractors and freeze hirings
  9. reduce the frequency of payment runs to once per month only
  10. offer early payment discounts to customers and focus on liquidity over profitability

Build on agility and be prepared to immediately downsize at any point

  • move fix costs to variables
  • review legal commitments
  • analyze contracts and notice periods (service contracts, lease contracts, supply, employment), be informed when to take action and when benefits can be seen in the cash flow
  • consider unpaid leave for permanent staff
  • plan plant go slow and shut down considerations

Retaining liquidity is mandatory, however, experience shows, liquidity infusions will be most likely required.

Short term sources of funding

Retaining cash protects liquidity. This is based on a firm’s rigorous policy for accounts payable, including avoiding any discretionary spendings, exploiting the flexibility of payment terms, prioritizing, and only partially balancing for liabilities due. To generate liquidity infusions, short term sources for funding include:

  • Remaining credit lines with banks (if not exhausted already)
  • extending support from existing funders (lenders, shareholders)
  • asset-based lenders, alternative lenders

Mid term sources for funding can include:

  • are government support and guarantees available? (e.g. subsidies for reduced working hours)
  • support from larger customers or suppliers
  • unutilized or idle assets or inventory, that can be traded or collateralized

Short term sources of funding may be suitable to support urgent OPEX needs, yet, are likely to fail to meet CAPEX or restructuring requirements.

Infographic Retaining Liquity in Situations of Rapid Change, Turnaround by Kolja Rafferty

Planning ahead for the next 3 months

To plan for the future, managers should explore scenario planning to be prepared for the next challenge, sure to come.

  • analyzing different downside scenarios for the next 3-6 months.
  • challenging critical assumptions and thinking of the unthinkable. identify the core assumptions of your business, and flex with the latest information. Make this a “Think Tank” routine, once a week. Include key personal from different areas of the firm for this (sales, production, finance…).
  • special attention must be given to risk management. Are cluster risks allocated in the customer portfolio? What will be the financial impact of breaches of contracts? By others? By yourself?
  • Identify risk for disruption in the supply chain and analyze cash impact.
  • Identify mitigating actions and define KPIs when they have to be taken. Observe and protect the KPIs.

With scenario planning, often further requirements for the infusion of liquidity beyond OPEX support are identified.

To obtain additional liquidity can be challenging for the management.

Liquidity management in situations of rapid change has to be addressed at credit facilities, as well as working capital.

Mid term working capital solutions for companies with urgent cash requirements

  • accounts receivables
    • close alignment with relevant customers informs about financial flexibility (and risks) along the value chain. The risk for disputes and late collections is minimized.
    • strict collection processes are paramount. Daily analysis of accounts receivables, prioritized for the amounts is a managerial basic.
    • review and analysis of customer payment terms, to identify arbitrage opportunities across customers.
    • adjust customer payment terms (e.g. set up fees, upfront settlements, etc.) and promote early payments e.g. via discounts.
    • run promotions and promote sales (even with diminishing profitability).
  • inventory & production
    • adjust inventory to (reduced?) production capacity and minimize batch sizes, to free up cash.
    • reorganize (renegotiate, delay, cancel) supplier deliveries, according to adjusted demand planning.
    • review demand planning at least weekly.
    • prioritize orders providing immediate cash inflow.
    • divest excess slow-moving and idle stock
  • accounts payable
    • align with suppliers
    • eliminate early payments
    • prioritize suppliers for payments
    • apply strict payment policies (pay upon 1st reminder instead of due date etc.)
    • explore Supply Chain Finance and Dynamic Discounting

Credit facilities for companies with urgent cash needs

Companies in distress situations, often have exhausted various instruments of refinancing already. Whereas Revolving Credit Facilities (RFCs) may provide the required flexibility for some firms, others may feel the urge, to visit their banks with requests for extension of credit facilities. Yet, banks will be often at the limits of their risk tolerance for a single debtor. “Usual” collaterals may be exhausted, and due diligence processes of banks, to grant further funds appear lengthy.

Opportunities for infusions of liquidity might be available through:

  • thoroughly check the balance sheet for residual assets, eligible to serve as collaterals
  • residual lenders are often shareholders or other stakeholders with already existing risk exposure or other interest for a company going concern. This may include suppliers, customers, (local) governments, or even employees.
  • for SME businesses personal guarantees, signed by the management/shareholder can be an instrument for banks, to grant funds
  • governmental agencies provide in some countries guarantees for funds, which may be linked to certain purposes (CAPEX, recovery)
  • assess opportunities for debtor factoring and asset-based lending facilities
  • Special Situation Funds can provide liquidity in forms of debt or equity financing
  • equity-based and convertible based tools of financing, offered at discounts, can be interesting for new shareholders.
  • merging with competitors or major suppliers can be a last resort, to avoid bankruptcy.

If things keep going south, be on the lookout for a landing spot

KPIs inform about the state of affairs, but decisions are done by humans. If a firm fails to turnaround through adverse market conditions or other circumstances, unnecessary harm can be avoided, by realizing and acting timely. A save grounding, fire sale to a competitor, applying for Chapter 11 or liquidating the firm, etc., is a painful and unpleasant step, that may offer only fractional recovery of investments. Yet, not taking action can become more costly, including total loss of shareholder equity, as well as, imposing the risk of personal liability, up to criminal charges on the executive as well as the non-executive board.

Take away

In situations of turmoil and distress, the focus of the management must be on winning time, to have the headspace to restructure and revitalize a business. Typically this comes down to a question of liquidity.
For the management this comes down to three areas to perform:

  • monitor liquidity and cash flows like your life is depending on it (in fact, in the economic sense, it is). Daily cash flow status, close monitoring of accounts receivables and scenario planning, and stress testing for the next 13 weeks are key.
  • focus on the next 4 weeks: Closely align with all stakeholders, to sense risk and danger early enough. Prioritize payments, in accordance to risk for the business. Explore flexibility in existing contracts and relationships, to expand the firm’s runway. Analyze your NWC; reduce inventory, divest idle stock. When promoting sales, think liquidity, rather than optimize profitability.
  • plan for the next 3 months: Utilize scenario planning and stress testing. Assess the balance sheet for residual collaterals. Exploit credit facilities and bunker liquidity. Anticipate the position of your lenders in terms of risk appetite, but also required time to process and execute liquidity infusions.
Leadership under heavy cash constraints infographic by Kolja Rafferty

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Kolja A. Rafferty, MBA, IDP-C, CTP

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