How a Distressed Company Can Manage Cash and Stakeholders in a Liquidity Crisis

Considerations for Companies in a Cash Crisis

A liquidity crisis is a severe financial situation in which a company does not have enough cash or cash-convertible assets, which can lead to defaults and bankruptcy. Managing cash is critical when working to preserve or maintain solvency in order to maximize opportunities for a successful turnaround or corporate restructuring.

Near-Death Liquidity Is Like a Melting Ice Cube

Insufficient liquidity shrinks the range of options for a financially distressed business. The metaphor of a melting ice cube is often used to illustrate this situation. Your cash is the ice cube. Unless the ice cube is refrozen (i.e., replenished) over time, it will eventually melt (i.e, run out). When no additional credit is available, cash runs out, and the company is unable to pay its employees or vendors, the ice cube has melted. At this point, the business has failed, and recoverable value collapses.

Business leaders who have never experienced a “near-death” liquidity crisis may lack the needed skill sets to address such predicaments. In these situations, outside assistance, such as from a restructuring advisor, is often required to develop and implement strategic alternatives. When corporate resources are spread too thin, it’s of paramount importance that management addresses its cash flow issues—and does so with a sense of urgency.

Situational Analysis and the Cash Flow Forecast

A situational analysis will provide a rapid, factual assessment of the current situation. This analysis must include a thorough review of the company’s cash position through a detailed cash-flow forecast that reflects all incoming and outgoing sources of cash.

An experienced restructuring professional’s review of the company’s strategic alternatives is based on a detailed 13-week cash-flow forecast, which is widely accepted as the appropriate tool for navigating through cash issues in crisis situations. The cash-flow forecast, finalized in budget form, must disclose cash sources and uses based on clearly stated and accurate assumptions. Earnings before interest, taxes, depreciation and amortization (EBITDA), which is often used as a proxy for cash flow in non-crisis analyses, should not be used for the crisis cash-flow forecast. This is because it can mislead by including non-cash items in the earnings component, and by excluding cash requirements associated with capital expenditures and working capital. Working capital requirements—or operating debt—includes accounts payable, accrued expenses, and other liabilities that will come due within a year.

Management must look for ways to accelerate incoming cash and conserve cash on hand while allocating cash disbursements. Managers are best able to lead their company through a full-blown liquidity crisis when assisted by outside advisors oriented toward fixing cash issues.

Throughout the process, cash remains king, and managing cash is of paramount importance. This applies to cash on hand, cash generated by operations, non-operating or one-time sources of cash, as well as other sources of liquidity. All must be considered in establishing options, developing strategy, and preparing negotiating positions to support an informal out-of-court restructuring, a bankruptcy filing, or another alternative (e.g., self-liquidation, Article 9 sale under the Uniform Commercial Code, assignment for the benefit of creditors).

To a large extent, the cash situation will dictate the company’s options and time frame for implementing its turnaround or restructuring plan. In almost every case, managers will need to simultaneously pursue multiple options on separate tracks.

Potential Issues in Managing Cash

Potential issues in managing cash include—but are not limited to—the following:

Borrowing Capacity/Excess Collateral Under Existing Borrowing Facilities

Typically, waivers of defaults under loan documents can be negotiated with secured lenders during early-stage distress. However, whether under the terms of a workout or otherwise (e.g., due to availability formulas or downgrade triggers), the company’s borrowing availability may be reduced. This could, in turn, precipitate a liquidity crisis.

Furthermore, if the lender deems its position to be less-than-well-secured, and if the lender concludes that operations will continue to erode its collateral position by “burning cash”, the lender might prefer pursuing asset foreclosure or a bankruptcy proceeding. Both options would protect its collateral position and make it easier to monitor management.

Considerations include:

• The debtor-in-possessions (DIP) financing’s ability—either with the existing lender or a new lender—to provide additional borrowing availability
• The status of existing defaults and lender fatigue
• The rates and fees associated with DIP financing proposal(s)

Access to Trade Credit from Existing or Alternate Vendors

Good relations with trade creditors (i.e., where payments to vendors have not been stretched to the breaking point) might enable the company to establish a standstill on “old” payables during implementation of the turnaround or restructuring plan, which would conserve cash and allow time to put in place cash-flow initiatives. With sufficient cash, it might be possible to negotiate a composition of creditors that provides for deeply discounted payments or extended financing terms on “old” payables while allowing vendors to keep or obtain a profitable customer relationship. Similar negotiations may ensue with landlords, in which case the financial terms of settlement will be influenced by the maximum claim to which the landlord is entitled in a bankruptcy.

Considerations include:

• The structure and number of vendors
• The current payment status on shipments made on open terms
• The length of relationships
• Collect-on-delivery (COD) requirements
• Lost suppliers
• Availability of alternate suppliers

Ability to Implement Profit Improvement and Cash Flow Initiatives

The cash flow forecasting process can provide:

1. Crucial insight into the drivers of operating cash flow and operating cash-flow margins, allowing detailed analysis of days sales outstanding, inventory turnover, unit volume changes, and pricing/cost trends.
2. Identification of opportunities to shorten the cash conversion cycle, accelerate cash flow, improve cash-flow margins on product and service offerings, and eliminate cash drains.
3. Evaluation of capital expenditure requirements, as well as non-core investments and activities, as these affect cash flow.

Considerations include:

• The extent that the company depends upon a limited number of products, services, vendors and/or customers
• The capital intensity of the business

Managing Stakeholders in a Liquidity Crisis

To communicate effectively with the other key stakeholders—senior debt, subordinated debt, trade creditors, employees, and equity—about cash issues and momentum towards resolving them, the turnaround team must be open about the cash realities facing the distressed company. The 13-week cash-flow forecast can establish credibility and trust among the stakeholders, which is critical to the successful management of the company and protection of creditors’ interests as the company passes from the vicinity of insolvency into actual insolvency.

It’s difficult to reach agreement on turnaround strategy among stakeholders who hold diverse agendas and are faced with uncertainty—and possibly confusing information, including competing valuations. By sustaining focus on cash issues, using appropriate tools for managing cash, and communicating the cash realities to all stakeholders, management and turnaround teams can minimize conflict over strategy and maximize company value for all stakeholders.

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[Editors’ Note: To learn more about this and related topics, you may want to attend the following webinars: Where Did All My Profits Go? Mastering the Concept of Working Capital and Negotiating and Drafting Cash Collateral/DIP Financing Orders. This is an updated version of an article originally published on December 12, 2018.]

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