Business disruption often shows up quickly in your organization’s cash flows. The wide-ranging repercussions from the COVID-19 pandemic have taken a dramatic toll, and your organization will likely feel a financial impact to some degree. 

The situation with the COVID-19 virus continues to evolve rapidly, particularly its reach in local markets. Without a finite end date to the public health safety measures many states and local municipalities have put in place, now may be the time to rethink your approach to cash flow management and evaluation. If you are starting to feel the pinch from new business slowing down, contracts being delayed or workers being kept from doing their core job functions, a well-crafted 13-week cash-flow model (TWCF) will serve as a reality check for all stakeholders and assist in highlighting a logical path forward.

The cash cycle in many businesses approximates 90 days (i.e., one calendar quarter or 13 weeks), which means an experienced financial consultant will appear to have a crystal ball when mapping out short-term cash-flows, because all the necessary data is available if one simply knows how to compile it. While every situation and industry is unique, the focus here is on a process that can be used in any situation, particularly one where there is no source of financing other than the cash generated by the business and potentially loan programs the government is currently rolling out to combat the very real cash flow crises that are facing many businesses as a direct result of the COVID-19 pandemic.

Why a TWCF?

Traditional accrual-basis financial statements are often unhelpful and can be misleading during a cash crisis. In a distressed organization where resources are likely constrained, time is better spent on developing an accurate cash flow. The concept of a TWCF is very simple — map out all sources and uses of cash during the upcoming quarter. The execution is more complicated, as large customers and suppliers will need to be analyzed individually. A well-formulated TWCF will provide a road map for running the business, while also tracking key balance sheet accounts to keep any lenders informed of their collateral position on a weekly basis.

Getting Started

Begin by reviewing the current sales backlog and understanding the sales cycle (i.e. how long from when the order is placed to when cash payment is received). Lead times for purchasing and production as well as how customers pay their bills may seem like subtleties, but granular understanding of these nuances will prove critical to the accuracy of your model. Are there large customers whose sales can be easily forecasted on a weekly basis? Depending on the length of the sales cycle of the business, as much as 100% of the sales for the upcoming quarter may already be included in the backlog. The longer the sales cycle, the more accurate forecasting of near-term sales in the upcoming 13 weeks can be done.

It will be important to identify sales to large customers, as you will need to estimate when cash payments will be received. Some accounts may have longer payment terms (i.e., 60 days versus 30 days), and certain customers with the same terms will have different payment histories (early, late, once a week or once a month, etc.), which can have dramatic impact on the timing of cash receipts.

Sources of Cash

Once the current sales backlog has been converted into a sales forecast that groups customers with similar payment patterns, the next step is to forecast the largest source (and potentially only source) of cash — collection of accounts receivable. At this point, it is best to work closely with the collections department to map out when the current receivables for the largest accounts will be collected (based on its knowledge of the customers, not necessarily the payment terms). Typically, the 80/20 rule is applied, and mapping a handful of customers will likely help establish a comfort level with the timing of the majority of expected cash receipts. COVID-19 pandemic considerations will be applicable here, with wide-scale disruption to the entire economy, supply chains across the world encountered complications as countries put travel restrictions and work-from-home recommendations into place. Entertainment and hospitality industries faced sharp and sudden declines in demand. Many retailers temporarily closed physical locations. Because everyone felt an impact on some level, the timing of payments coming into your organization might also be different in the current environment.  On the flip-side, however, vendors that may have traditionally been rigid in collection policies may make exceptions. 

Before moving to the expense forecast, think about any other sources of cash that may be available to the business. For example, are loans available from government stimulus programs? Can excess or obsolete equipment or inventory be sold? Is there a life insurance policy with cash surrender value?

Uses of Cash

Next step is to forecast cash needs for the next 13 weeks. First, identify the recurring weekly or monthly cash expenses — such as salaried payroll, direct debits from bank for interest or fees — that do not run through accounts payable. Once these non-accounts payable expenses are plotted out on a weekly basis, focus will turn to the detailed accounts payable aging, which in is the historic context of the COVID-19 pandemic may already be stretched well beyond payment terms when first preparing the TWCF.

When reviewing balances due to large suppliers, involve members of the management team with the best relationships with each of the suppliers. Discuss as a management team which suppliers are most critical, which could be easily replaced (and payment delayed) and which ones may be most receptive to setting up a payment plan on past due invoices. This exercise is extremely important, as maintaining supplier relationships will help the company avoid unnecessary supplier turnover and continue to meet customer demands.

Balance Sheet and Borrowing Base Considerations

Once you have plotted out all sources and uses of cash in the upcoming 13 weeks, you should calculate weekly snapshots of key balance sheet accounts (particularly accounts receivable, inventory and accounts payable). By calculating anticipated accounts receivable on a weekly basis, you will quickly see if the sales and collections forecasts developed are reasonable in comparison to recent borrowing base calculations. In cases with a secured lender watching over its collateral, this information feeds a borrowing base calculation that will keep the lender informed of its collateral position throughout, and give you the credibility to discuss potential upcoming issues with the management team and lender.

What is the TWCF Telling Me?

Review your anticipated cash balance at each day’s or week’s end to see if it is positive throughout the upcoming 13 weeks. If it is positive, review the assumptions again, particularly the sales and accounts receivable collections forecasts and make sure the forecasts are realistic, not optimistic.

If cash is negative at any point during the forecast, the company and financial consultant will need to review options for potentially: borrowing funds; accelerating receipts of cash (if the company is operating under a borrowing base, a real push should be made to collect ineligible receivables and liquidate ineligible inventory at this time); or eliminating or delaying expenses.

If none of these options are realistic and the negative cash position is sustained and not just an isolated timing issue, focus should turn to the specific government loan programs designed to assist companies with navigating the COVID-19 pandemic. Seasonality in the nature of the business (e.g., a landscaping company) needs to be considered at this time, as cash shortfalls in the near term (next 13 weeks) may be rectified during peak times.

Maintaining the TWCF

The TWCF should be updated on a weekly basis and all assumptions made should be clearly documented and can be refined as necessary. Be careful not to “override” the forecast of the week being updated; instead, document the actual results in a separate column so that comparisons of forecasts can be analyzed on a weekly, and more importantly a cumulative basis. It is important to reset key account balances (cash, line of credit, accounts receivable, outstanding checks) in the forecast to actual each week so that the go-forward forecast is not skewed by timing differences.

As the management team becomes more comfortable with the tool and its inputs, they will gain confidence in their ability to forecast future cash needs. This will allow the company to:

  • Navigate short term cash management challenges, such as those caused by the sudden onset of COVID-19;
  • More effectively negotiate with its lenders and explain upcoming borrowing needs; and
  • Regain confidence with its suppliers

Conclusions

A well-developed TWCF, monitored on a weekly basis will provide all stakeholders visibility to the near term survival of a company that traditional accrual-based financials simply will not. This illustrates why a TWCF has long been the gold standard reporting tool in a distressed situation before the COVID-19 virus and will continue to be after the COVID-19 pandemic. Experienced financial consultants don’t have crystal balls and we don’t walk on water — instead, we know how to formulate cash-flow models; we know where the rocks are. For more information, please contact us or visit our COVID-19 resource center.

Published on March 31, 2020