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COVID-19 and Cash Flow Management

COVID-19 and Cash Flow Management

Apr 10, 2020

By John D. Poppe, Jr., MidCap Advisors, LLC

To say the past few weeks have been disruptive to our typical way of life, and how we transact business, is the ultimate understatement. Unprecedented government-dictated measures have wrested operating control away from business owners as macro public health concerns dominate our national agenda.

As a result, business owners are now forced to make very difficult decisions with cash receipts unpredictable for the foreseeable future. Preserving liquidity is paramount now. Organizations are wildly altering their historical cash flow norms throughout supply chains. To empower business owners to wind their way through this unimaginable scenario, here are some key matters to consider.

Evaluate Your Probability of Receiving Cash

Throughout the duration of this crisis, anticipate an extended collection period for accounts receivable. To assist in projecting cash receipts, evaluate your accounts receivable and determine if you are an A, B or C vendor for your primary customers, with the assumption being that the closer you are to an A vendor the higher the probability of being paid near the credit terms you have extended, assuming the financial stability of such customers has not been severely shaken.

Next, factor into your forecast that even your best paying customers may need some payment flexibility. And, expect an increase in delinquencies. Assume minimal — if any — cash receipts from invoices more than 60 days past due, particularly if substitute vendors for your product or service are easily procured. If you have a factoring arrangement or asset-based lender, review your agreement to determine if there is any recourse due for non-payment by customers. Also, evaluate risk to the definition of ineligible receivables.

Focus on Disbursements

Even with the most thoughtful revenue forecast, the potential deviation in actual receipts is substantial, so focus on what you can control — disbursements. As the rate of return to pre-pandemic demand levels is presently unknown, evaluate your cost structure in volume increments. Begin by mentally stripping your operation down to the studs. What costs must you pay even if you are not operating? Every aspect must be evaluated – even rent. Most lessors will likely be cooperative as it is in their best interests that your company continues to operate. Outside of payroll, one of the larger recurrent business expenses is healthcare insurance premiums. Check with your broker for any potential payment flexibility. Connect with and stay in close touch with your banker throughout this crisis. An informed banker will make efforts to help steer your business through a time of crisis.

Recommencement of Operations

Once you have a handle on your “floor” of disbursements, focus your cash disbursement analysis on recommencing operations. Evaluate your current order backlog against available inventory, if applicable. What do you need to ship out to satisfy the current backlog? Estimate all associated costs: new materials to be ordered, personnel, facilities costs. Take a bare bones approach to identify sub-optimal costs that may have crept into the operation. Consider:

  • What is the credit quality of the customers in your current backlog?
  • Will you ship under the same credit terms?
  • Will vendors provide your company with the same credit terms?
  • Can payment schedules be negotiated with vendors? Are there better alternative vendors?
  • Changes to processes (what’s required versus what’s desired)?
  • Can personnel increase multi-tasking?

Building Outward

Now, evaluate the incremental costs of expanding output in 25% increments. Again, constrain the operation in your thoughts. Take a hard look when assessing the various aspects of your operation. In a complex system, it is best to segment system aspects into the analogy of a bathtub – one input and one output. This simplified approach assists in taking out “noise” — that is, costs — that may emerge as a company develops from an atom to a compound. Keep your focus on the direct expenses necessary to generate revenue. Establish the product or service contribution margin. Allocate additional personnel such as production management, supervisors, sales and administration into operating expenses. Consider:

  • What is the stability of input vendors?
  • Are full-time or part-time employees needed? What shifts are to be worked?
  • Methodology of returning employees to the operation and human resource compliance.
  • Consistent focus on the cash conversion cycle at each increment.
  • How much working capital will you need?
  • Will you have sufficient resources to execute?

Plan it Out: The 13-Week Cash Flow Model

Establishing an incremental cost view of the company should assist in proactively managing your operation as we emerge from this unprecedented environment where much of our economy is paused. To assist with anticipating cash flow constraints, it is helpful to incorporate this incremental view into a 13-week cash flow model. Using a basic 13-week cash flow model and incorporating incremental sales volume assists in determining working capital sensitivity and provides a roadmap to help navigate the unknown road to normalcy we are all seeking to traverse once more.

We are all in this together. This very basic overview has many underlying complexities. Tap into MidCap Advisors’ extensive expertise in advising and operating lower middle market companies with a complimentary 13-week cash flow review. It is our way of contributing during these challenging times. Contact me directly at (212) 722-7163 or john.poppe@midcapadvisors.com

BMK invites articles that may be of interest to our clients, colleagues, and friends during these trying times. BMK is not affiliated with MidCap Advisors, LLC and it does not endorse the content or views expressed by MidCap Advisors, LLC or by Mr. Poppe. Should you have questions or comments concerning the article, we suggest that you contact Mr. Poppe directly via the telephone number and email contact information provided.

The article is not and cannot be construed as legal advice.

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