Thought Piece

This guide is aimed at turnaround professionals whose expertise is in a different area to cash management or who come across cash crises infrequently. As well as for new members who may find it useful to consider one of the various approaches to evaluating and addressing cash issues immediately on arrival in a new business. Any professional who regularly addresses cash crises is unlikely to learn anything new here.

Much of this is based on a talk given regularly at London Business School’s, Managing Corporate Turnaround MBA module. The first section describes what might be seen when a business is going into a cash crisis. If it’s already clear that there is a cash crisis, some of the things that might done can be found further down.
Recognising a cash crisis

Often, when looking at a business for the first time, it’s good to look at the cash first. This provides a clear understanding of the quality of the recording of underlying transactions.

When a business starts to grow, particularly if it's a manufacturing business, then the cash situation can become important. Also, when a business is going through a downturn, cash is particularly important. Growth or downturn indicates that there could soon be a cash problem at some point.

At the same time, identify and keep a wary eye on the near-cash items that sit on the Balance Sheet. Pointers can often be found in routine accounting. Traditional Working Capital Ratios are perfectly adequate to indicate a problem. If the Working Capital Ratios start to move in an adverse direction – that's the juncture to initiate a thirteen-week cash flow projection and update it every week. Keep an eye on it, manage what's going on until the Balance Sheet ratios turn back to green and indicate that it’s now possible to put effort in a different direction for this particular finance function, in this particular business, at this particular time.

Build a cash flow projection that incorporates the business’ payables and receivables, which reside within the balance sheet and how they’ll unwind over time into cash – consider a period of four to six weeks. Then see what's currently in the Sales and Purchasing pipelines. Feed in other events that are likely to happen and explore how all this will unwind over another four to six weeks. For the last few weeks of the projection evaluate the momentum of the business and how this is likely to produce cash. Finally, in the thirteenth week, try to think of all of the things that affect cash that might have been forgotten and put them into the 13th week. Repeat this process weekly and very soon, a picture will march across the page, flagging up the things that need to be done.

Now it is established that a cash flow projection is likely to be needed for the short to medium term, it’s worthwhile spending a little more time on its construction.

Gathering information

A useful tool for cash crisis stabilisation is a dynamic graph that displays the likely future cash flow visually. Once built and refreshed every week, this chart can be absorbed and understood in one or two minutes and if there’s no sign of anything obviously wrong, the team can get on with something else. If risks are revealed, it makes sense to spend more time with the granular data to establish sensible next steps.

Three time-horizons

Thinking again about the thirteen-week cash flow projection, it’s most useful if it is refreshed on a weekly basis. A useful way to organise it is in three separate time-horizons, each with a different kind of information and data sitting underneath it.

This enables analysis of each time-horizon with a different focus and not just one big sweep. The first four weeks will simply be an unwind of the balance sheet. This review is particularly valuable on arrival and during the first four weeks in a finance function –it will reveal things about how the function operates.

The second four weeks is an unwind of activity that's already been prepared and planned for. This time-horizon will reveal how financial transactions emerge from business transactions. This provides insight into activities like production, dispatch and buying, and helps to understand – not just what’s going on in the finance function – but also how the business operates.

The third four-week time-horizon moves into the area of forecasting. It makes it possible to make forecasts based on run rates or statistics or other activities.

Finally, it’s time to look at the thirteenth week. Take some time every week, while refreshing the cash flow projection, to think about what may happen in that thirteenth week. What about the VAT return? What about taxes that might be paid? What about payments to the bank?

With understanding of those things, it will be possible start to produce it on a weekly basis. The pieces that went into the thirteenth week during its second production, will then be in the 12th week and then it'll be in the 11th week.

Now the peaks and troughs of how the cash flow is getting together will become visible, coming across the page – and as they approach the present, there may be time to think about what actions could be taken to change the outcome. It might be possible to speak to people, to negotiate payment terms, or get financing, or other options.


What can be done?

A key point for the thirteen-week projection is, as much as possible, to use granular data. For the first time-horizon, it’s already established that there is an unwind of transactions into cash, which should already be recorded in the accounting system. These are gleaned mainly from looking at receivables and payables and setting them out across the page. These are rich sources of granular data, and they can be sorted. For example, put A payables at the top, the ones that can switch the business off straight away, and put the B payables in the middle and the C payables at the bottom. The C payables are normally small businesses and small amounts; in total they are unlikely to be 20% but are also likely to generate 80% of the calls. Wherever possible, just pay the Cs, to avoid generating lots of telephone calls.

Since it is important to preserve cash to pay the As, look at the B payables These are the ones where it's possible to negotiate with the suppliers. They're relatively large transactions so a decent conversation is likely to be possible. It's surprising how often people will be glad to be contacted and to get an honest request.

Receivables is another other key tool to smooth cash flow during a crisis. Again, use categorisation may be a to guide thinking. It can be useful to organise according to time, for example Fresh, Stale and Old could be categories.

Freshly invoiced amounts are often the ones that are easier to collect. A concerted effort in this area can make a big difference. With stale invoices, on the other hand, quite often there can be little mistakes that when corrected enable payment. Attention is required to ensure that small errors or customer concerns are immediately addressed.

Although old invoices is often thought of as an area of first attention, it can quite often be the case that this is where disputes lie. Therefore, if cash is required quickly, it is not always to be found in the resolution of these disputes that is not to say that they don’t need to be resolved and the cash collected. It’s just a matter of timing.

Having discussed how to recognise a cash crisis, how to gather clues about its origin and where to look for useable cash, what follows is a final remark about the two completely different concepts that are often described using the same term – cashflow.

Two types of cashflow

Describing how cash flows through a business, one phrase cash flow is often used for two different concepts. One takes place over months or years and can be thought of as the funds flow. The other takes place over weeks or at most, say, three months. This is the thirteen-week cash flow projection described above.
The funds flow concept starts in a more holistic way. It illustrates, over time, how the profit of the business translates into cash. It describes movements in the balance sheet, and it takes in the profit statement. It says, “What's the profit?” It’s then possible to add back those components that go through the profit and loss account, for example, depreciation that don't turn into cash. Then, taking how much the company is owed, how much it owes and how much it’s borrowed from the bank or obtains from shareholders, as well as operating cash into consideration and this will provide an overall funds flow statement.

When somebody says, we need a cashflow statement, then ask the age-old question, what will it be used for? To forecast over a longer period or to try and assess whether a business is viable or to make an investment decision, then select the one that's between the balance sheet movements – the funds flow statement will be most useful. Alternatively, if the need is to know how much cash is available week-on-week, to cover the payroll, then the thirteen week rolling cash flow projection will be the most appropriate.

Banks are not charities. But they do calculate the lifetime value of the customer and they understand the reputational risk to themselves of the slash and burn exercises they are sometimes accused of.

That brings us to the role of the banks, so often the largest creditor and certainly the one with the most intimate knowledge of how a company is faring. We all love a stereotype and the heartless, faceless bank pulling the plug on sound businesses over a minor blip sits deep in the business consciousness. But not all banks fit this caricature. "We want to work with management of a business facing difficulties to help identify the issues and provide solutions to get them back on track," says a senior manager with a leading retail bank. "We can make the most impact when the problems are identified early. We are keen for management to be open with us."

Banks are not charities. But they do calculate the lifetime value of the customer and they understand the reputational risk to themselves of the slash and burn exercises they are sometimes accused of. Most solutions to business difficulties involve access to more funds and/or different products (hedging, leasing, factoring) and that all adds up to continued and profitable involvement for the bank.

A Repositioning Turnaround may mean divestment of a troublesome subsidiary. It may mean embarking on (yet another) cost-cutting exercise, including turning away revenue opportunities if they are not of a sufficiently high margin. It most certainly involves a first step of getting an impartial and pragmatic overview of what the problem actually is, from Turnaround Professionals who also know the kind of language with which to talk to banks. The moment you take this kind of decisive action, you're likely to discover that there's no crisis, no drama, only urgent action that must start now.

Peter Charles 2010