Importance of Cash Flow and Liquidity During a Crisis

By March 26, 2020 May 19th, 2020 COVID-19 Insights
Importance of Cash Flow and Liquidity During a Crisis

As the fallout from the novel coronavirus, COVID-19, outbreak continues to devastate the American and global economies, many companies are searching for ways to demonstrate their resilience. For small businesses and startups, uncertainty comes with the territory.

However, the current environment has resulted in especially complex challenges for the future. Now the focus for most businesses is on protecting their employees, understanding their unique business risks, and managing the effects of supply chain disruptions. In these uncertain times and with a possible recession looming, cash and liquidity are of paramount concern.

Who is most vulnerable?

Businesses that are currently struggling for profitability – those with low cash reserves or unstable cash flows – are particularly vulnerable at this time. However, even businesses that appear to be in good financial shape may not be immune. The length of the situation and how it progresses, as well as how long it takes for demand and supply to return to normal are key factors for any business in any industry.

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Businesses involved in tourism, hospitality, entertainment and air transportation have been particularly hard hit in the short term. Likewise, those businesses operating in the consumer goods and retail spaces may also be at higher-than-normal financial risk, especially those in seasonal businesses where demand may be lost (as opposed to shifted), such as perishable consumer goods and seasonal apparel.

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How can I respond to immediate cash flow challenges?

Given the importance of cash flow in times like this, it is important to strategize intelligently and make sure you are aware of all of your options. Some practices and strategies for your consideration include:

1. Evaluating your cash and working capital needs

Cash is the lifeblood of any business (as the recent stimulus package indicates). In a volatile and slowing economic landscape, getting an immediate handle on your daily cash needs is essential. Take a critical view of operations, review existing cash flow forecasting processes and understand how potential disruptions to operations may affect liquidity.

Run different scenario analyses on your financial and cash forecast and understand how each potential situation interacts with your short-term liquidity needs. Doing so may also highlight any borrowing base or covenant breaches that you may face and can help shape any short-term management decisions.

It is wise to strategically manage your working capital, potentially selling inventory or minimizing new inventory purchases to generate cash. Take a critical look at working capital KPIs such as days payable outstanding and days sales outstanding and understand impact of stretching these days in either direction. Assess capital expenditure requirements and defer non-essential spending if possible.

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2. Optimize your costs

It can be difficult to maintain your current or historical levels of profitability in an environment where supply and demand fundamentals decrease simultaneously without closely analyzing your spending. During this time it is important to develop a strategy. Flying blind may lead to compromised revenue generating capabilities or diminished value.

Instead, review fixed and variable costs carefully and determine what costs you need to actually run your business. Reducing variable costs, for example, can immediately reduce cash outflows. Some ideas are imposing travel and non-essential meeting restrictions, imposing hiring freezes, and limiting spending on entertainment and training. Another option is reducing contract labor and re-distributing the work to your permanent workforce.

You should also revisit any capital investment plans. With cash flow forecasts in mind, consider what is really necessary for the short-term success of your business. What capital investments can be postponed until the situation improves? What capital investments should be reconsidered altogether? And what capital investments are necessary to position your company for a rebound a competitive advantage?

Look to develop and monitor cost reduction initiatives, such as rationalizing SG&A, and take a close look at headcount and instituting policies that encourage and reward cost savings and conservation.

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3. Focus on the cash-to-cash conversion cycle

Under normal business conditions, companies primarily focus on the profit and losses, or growing the top line while managing the bottom line. Routine back-office activities like paying bills and turning receivables into cash are often taken for granted.

However, in today’s abnormal business environment, some companies are shifting their focus from the income statement to the balance sheet. In order to minimize working capital requirements during challenging times, it is important to apply a coordinated approach that addresses payables, receivables and inventory.

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4. Evaluate customers and suppliers

In times of economic uncertainty, businesses could experience increased pressure on the purchasing power and credit-worthiness of customers while also facing tighter credit terms and product availability from suppliers.

Depending on what industry you operate in, your customers might be having some specific new pain points related to the coronavirus. Think strategically about how the pandemic is affecting your customers, what is keeping them up at night and how you can help.

Do not assume they are financially healthy. Consider reevaluating credit terms, negotiating reasonable terms and carefully reviewing the credit-worthiness of each new customer before extending credit.

Be sure to continuously monitor accounts. Failing to collect receivables in a timely manner (or even on an accelerated basis) may result in a cash flow shortfall that could have an immediate impact on all areas of your business.

Also consider negotiating for the most favorable credit terms with suppliers. Additionally, critically evaluate your supplier base to determine if your current agreement is still the most favorable option for your business.

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5. Consider alternative or non-traditional streams of revenue

If your scenario planning reveals pressure on your continued revenue streams, consider ways you could temporarily or maybe even permanently replace that revenue.

For example, if your primary markets are international, how might you transition and appeal to domestic markets (especially if your inventory is perishable)? If you have assets that generate revenue, could you utilize those assets in another way to generate alternate revenue sources? Not only could this reduce some of your top line pressures, it could also mean not having to reduce your cost lines significantly (not to mention a potentially more diversified revenue mix in the longer term).

Even as more of the country goes into lockdown, people still want and need to buy things. The opportunities to serve your market via alternative sales are there. Now is the time to get creative. For example, if you experience reduced foot traffic to your retail business, look to expand your e-commerce offerings.

Restaurants, among the hardest hit industries right now, have shifted toward takeout and delivery options to try to make up for the loss of dine in sales. Gyms have started offering livestream videos of their classes, posting at-home workouts on their apps, and encouraging their instructors to provide tutorials and workouts on their own social media channels. So what can you do?

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6. Communicate early and often with your lenders

Your existing lenders will likely know you and your business best. On top of that, they are acutely aware of the situation playing out across the nation and the globe. It is best to communicate with them early and often, explaining any situations that may arise and the actions you propose to address them.

Transparency and open communication will serve you both well. Besides, general proactivity demonstrates responsibility here and may encourage your lenders to work with you. They would rather you take the initiative than wait to miss payments. Foster that strong relationship with your lender – they could be your fastest source of additional liquidity.

Some items to consider:

  • Evaluate potential covenant breaches based on the outcome of various scenario analyses impacting your financial forecast.
  • Conduct detailed modeling of your working capital facilities, particularly with asset-based loans.
  • Stay current on your debt if possible and assess capital structure concerns, including possible refinancing or recapitalization alternatives.
  • Engage in key stakeholder and lender discussions early to allow yourself the time and liquidity to address your immediate potential financial challenges.

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7. Understand your business interruption insurance

Companies should understand existing business insurance policies and the coverage they have in the event of significant business disruption. Such insurance generally covers losses arising from disruptions to a business’s customers or suppliers – both of which seem to be the case in the current situation. However, the breadth of coverage can vary significantly by insurer policy, industry and geography.

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8. Use data to make informed decisions

All industries are affected by our current environment, so it is more important than ever to have the most current and up-to-date information.

Consider a 13-week cash flow model to highlight some of the critical decisions you make during this time. A 13-week cash flow model is a preferred analysis tool performed to give you and potential lenders insight into the next 90 days’ sources, uses and cash positions with the appropriate level of accuracy.

It is assembled and updated on a weekly basis, thereby generating detailed information which is readily available in advance of the typical monthly financial close process. As a result, you are able to make more informed (and difficult) decisions.

These decisions and activities will likely involve many of the topics mentioned above, including: customer credits and discounts, fixed and variable costs reductions, supplier term negotiations, lender negotiations, landlord negotiations, organizational changes, federal and state stimulus program applications, and more.

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How can Squar Milner help?

We have deep expertise in working with clients in the industries most affected right now. But more than that, we have people who have been a part of these industries and understand the ins and outs and the most important and specific concerns.

Now we are ready to step in and help your business come up with strategic and dynamic options to facilitate healthy cash flow and make it through to the other side of this global disaster.

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Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.

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