[Editor’s Note: This is an update of an article that originally appeared in May 2013.]
When working to preserve or maintain solvency to maximize opportunities for a successful turnaround or restructuring of a distressed business, managing cash is critical.
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 ice cube is refrozen (or cash replenished) over time, it will eventually melt (i.e run out). When no additional credit is available and cash runs out, 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 “near-death” liquidity crises 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 and tactical 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.
[Editor’s Note: For a great discussion on options for struggling businesses, we recommend Help, My Small Business Is In Trouble.]
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 and development of a detailed cash-flow forecast, reflecting all incoming and outgoing sources of cash. An experienced turnaround or restructuring advisor’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 because it can mislead by including non-cash items in the earnings component and 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. Assisted by outside advisors oriented toward fixing cash issues—together with their own familiarity with the business—managers are best able to lead their company through a full-blown cash crisis.
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 the pursuit of 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.
[Editor’s note: For more information on the importance of cash and liquidity to distressed companies, please see Cash Is King: The Importance of Liquidity in a Distressed Company’s Capital Structure.]
Potential issues in managing cash include—but are not limited to—the following:
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 could find its borrowing availability reduced, which could, in turn, precipitate a liquidity crisis. Furthermore, if the lender deems its position to be less than well-secured and concludes that operations will continue to erode its collateral position by “burning cash” (operating with negative cash flow), the lender might prefer pursuing foreclosure on the assets or a bankruptcy proceeding, both to protect its collateral position and make it easier to monitor management.
Considerations include whether the debtor-in-possession (DIP) financing in bankruptcy—either with the existing lender or a new lender—would provide additional borrowing availability, the status of existing defaults and lender fatigue, as well as rates and fees associated with DIP financing proposal(s).
[Editor’s Note: To learn how valuation can affect these issues, please see Valuation: The Pillar of Corporate Restructuring.]
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, current payment status on shipments made on open terms, length of relationships, collect-on-delivery (COD) requirements, lost suppliers, and availability of alternate suppliers.
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, as well as how capital intensive the business is.
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.
Steve San Filippo is the founder and principal of San Filippo & Associates. He has over 30 years of management experience providing restructuring, rebuilding, remaking, and transformational leadership to privately owned companies. Steve has assisted clients globally across a wide range of industries. During the past five years, he has served as chairman and chief…
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