Financial Planning & Analysis Archives - Page 10 of 16

Principles of Measuring and Managing Liquidity Risk

July 22, 2020 by 8020 Consulting

Finance professionals who vividly remember the 2008 economic crisis often associate liquidity risk with the Basel Accords, a series of banking regulations designed to ensure that financial institutions mitigate risk by maintaining adequate capital. In this post, we’ll look at things from another angle, exploring the principles of measuring and managing liquidity risk in the context of non-financial institutions.

Before we consider that subject, however, it is important to first understand some of the possible sources of liquidity risk.

Sources of Liquidity Risk

To put it simply, liquidity risk is the risk that a business will not have sufficient cash to meet its financial commitments in a timely manner. Without proper cash flow management and sound liquidity risk management, a business will face a liquidity crisis and ultimately become insolvent.

As businesses go about the process of measuring and managing liquidity risk, they need to be on alert for common sources of that risk. Those sources include:

1. Lack of Cash Flow Management

Cash flow management gives a business good visibility into potential liquidity challenges and opportunities. Cash is king, and cash flow is the bloodline of all businesses. Without proper management of cash flow, a business will increase its exposure to unnecessary liquidity risks. Moreover, a business without healthy and well-managed cash flow will face an uphill battle to remain profitable, secure favorable financing terms, attract potential inventors and be viable in the long run.

2. Inability to Obtain Financing

A history of late debt repayment and/or non-compliance with loan covenant requirements may translate into additional challenges when attempting to secure financing. Therefore, it is imperative that businesses have good capital structure management, match debt maturity profiles to assets, and maintain a good relationship and regular communication with lenders. The inability to obtain funding at all or to obtain it at competitive rates and acceptable terms increases liquidity risk.

3. Unexpected Economic Disruption

At the start of 2020, the stock market was at its all-time high, and few people expected the world would be so hard hit by COVID-19. The adverse economic impact of this global pandemic was swift and relentless. Lockdowns created an unexpected economic disruption, and many businesses saw sales dwindle to a catastrophically low level and liquidity risk drastically increase.

4. Unplanned Capital Expenditures

Having proper fixed asset management is extremely important, particularly for a business that operates in a capital-intensive industry such as energy, telecommunications or transportation. A capital-intensive business is often highly leveraged with a high fixed to variable costs ratio. For businesses like these, a single unplanned capital expenditure, such as a new purchase or major equipment repairs, may exacerbate existing budget constraints. This, in turn, further increases operating leverage and heightens liquidity risk.

5. Profit Crisis

A business in a profit crisis will not only see a decline in its profitability margins but also a decline in its top-line revenue. Consequently, to combat negative profitability margins and remain in operation, it will need to start dipping into cash reserves. Failure to stop a continuous cash burn will eventually deplete cash reserves, with the business inevitably facing a liquidity crisis.

Need help with your cash flow forecast? Learn about our cash flow consulting services.

Measuring Liquidity Risk

One of the key elements of measuring and managing liquidity risk is the ability to identify the warning signs of a liquidity crisis. Beyond the identification of these signs, a business must also be able to measure risk magnitude so that it can take immediate and appropriate action to stop a downward spiral.

There are several ways of measuring liquidity risk, namely:

1. Analysis of Financial Ratios

Good liquidity management means performing financial ratios analysis, understanding what these ratios mean, and taking the necessary best course of action. Financial ratios provide a business with current indicators of liquidity risk based on its past performance, allowing it to make the required financial and operational tweaks to ensure it attains desired future financial and operational outcomes. The most common ratios are:

Quick Ratio

Just like current ratio, quick ratio measures how well a business can meet its short-term financial obligations. Quick ratio is calculated by dividing the total cash, marketable securities and liquid receivables of a business by its total liquid current liabilities. A quick ratio of more than 1 means that the business is well-positioned to meet its short-term financial obligations. Less than 1, and the outlook goes the other way.

Current Ratio

Just like quick ratio, current ratio measures the liquidity level of a business and its ability to use short-term assets to repay short-term obligations. Current ratio is calculated by dividing the current assets of a business by its current liabilities. A current ratio of over 1 is normally considered to be comfortable. A ratio below 1 may indicate a shortage of funds to meet short-term financial obligations.

Quick Ratio vs. Current Ratio

Quick ratio is preferred over current ratio because not all current assets are liquid. For example, most businesses have trade debtors who carry an accounts receivable balance past 180 days, and there is a high chance that some of these current accounts receivable will not be collectible (i.e., not liquid).

2. Cash Flow Forecasting

During any time of uncertainty, especially now, businesses should more than ever re-evaluate their operational strategy and profitability forecast. Importantly, management must have good visibility into potential liquidity difficulties and opportunities. That said, it is always prudent for a business to maintain and revise its cash flow forecast, crisis or no crisis.

Measuring and managing short-term liquidity risk is particularly critical for a business that has large transaction volume, such as a supermarket or restaurant. Longer-term cash flow forecasts can be used to support the strategic objectives of the business and provide financial details for lenders.

A cash flow analysis must be realistic and informational, allowing visibility and execution of management’s plans, justifying the merits of business strategies and aiding accountability.

3. Capital Structure Management

Debt is usually the cheapest source of financing given that debt has a lower cost of funding than equity and is also tax-deductible for a business. However, a business must manage and monitor its debt to equity ratio closely so that it will not become over-leveraged. The more highly leveraged a business is, the greater its vulnerability to any downturn in cash flow. This vulnerability becomes even more serious if it coincides with times for debt repayment. A highly leveraged business has less capacity to absorb losses or obtain rollover funds.

To measure liquidity risk due to over-leverage, a business should look to see if it has enough liquidity to pay its debt interest and principle, and it should compare its gearing ratios to its competitors. The common leveraged (i.e., gearing) ratios are:

Debt-to-Equity Ratio

Debt-to-equity ratio measures the total liabilities of a business in relation to its shareholder equity. There is no optimal ratio. It really depends on the current health of the business as well as the industry that it is competing in. For example, a high ratio might be desirable for a business that is experiencing high growth because leverage significantly increases its returns. However, if a business does not manage the amount of debt on its balance sheet, the high cost of borrowing will impede any benefits from leverage and increase the likelihood that the business will not be able to service its debt (i.e., liquidity risk).

DuPont Analysis

Return on equity (ROE) is a profitability ratio that measures the rate of returns generated by invested equity (i.e., common stock). A higher ROE usually means that a business is more efficient in generating returns than its peers; a lower ROE means the opposite. DuPont analysis breaks down ROE into three components:

Operating efficiency;
Asset use efficiency; and
Financial leverage.

ROE = [Net Income/Sale] × [Sales/Total Assets] × [Total Assets/Shareholder Equity]

ROE = Profit Margin × Asset Turnover × Financial Leverage

These three components help a business better understand changes in its ROE over time.

As the profit margin increases, every sale will bring more cash flow and result in higher overall ROE. As asset turnover increases, a business will generate more sales per asset owned, also resulting in higher overall ROE. Lastly, an increase in gearing should result in an increase in ROE because debt is usually the cheapest source of financing. The increased use of debt as financing will cause a business to have higher interest payments, which are tax-deductible. Because dividend payments are not tax-deductible, maintaining a high proportion of debt in a capital structure leads to a higher ROE.

By understanding the financial leverage component of DuPont analysis, a business can make an assessment to determine if increased liquidity risk, through the increase in leverage, can be offset by the benefits of a higher ROE.

Interest Coverage Ratio

Interest coverage ratio measures how easily a business can cover its interest expenses on outstanding debts. Interest coverage ratio is calculated by dividing earnings before interest and taxes (EBIT) by the total amount of interest expense on all outstanding debts. The higher the ratio, the lower the credit risk is to lenders. In turn, lenders will be more willing to support financing needs, thereby decreasing liquidity risk.

Learn more in these related posts:

Managing Liquidity Risk

As we continue to look at the principles of measuring and managing liquidity risk, it’s time to turn to the management side of things. Liquidity risk can be mitigated through conscious financial planning and analysis and by forecasting cash flow regularly, monitoring and optimizing net working capital and managing existing credit facilities.

1. Forecasting Cash Flow

Many businesses, especially high growth ones with healthy balance sheets, diligently forecast their profit and loss but often neglect to forecast their cash flow because illiquidity has never been a concern.

However, it is imperative that all businesses regularly forecast cash flow in tandem with their other financial performance projections. A robust cash flow forecast will not only help businesses avoid having liquidity issues when they unexpectedly face higher than normal expenses but also reconcile the two key financial parameters of cash flow and profit. No matter how large a profit a business makes, if it cannot convert that profit into cash, it will not be able to meet financial obligations such as covering payroll, paying for inventory, increasing liquidity, and avoiding insolvency risk.

Regular cash flow forecasting also forces businesses to better optimize net working capital to meet long-term financial goals.

2. Monitoring and Optimizing Net Working Capital

Financial professionals need to have an in-depth understanding of how business fluctuations affect financing and net working capital requirements. Improvements to working capital can be achieved through three statement projections and analysis of financial ratios such as:

Days Sales Outstanding (DSO)

DSO measures the average number of days a business takes to collect payment from a credit sale.

DSO is calculated based on average accounts receivable divided by total credit sales times 365 days. A low DSO implies that a business takes a shorter time to collect its payments from credit sales and vice versa.

There is no ideal DSO value because DSO varies hugely by industry. In addition, DSO trend is more important to analyze than actual DSO value. For example, an increase in month-on-month DSO value may indicate a fall in accounts receivable collection efficiency or that some customers are taking more time to pay the business.

Days Payable Outstanding (DPO)

DPO measures the average number of days a business takes to pay its trade creditors.

DPO is calculated based on average accounts payable divided by cost of goods times 365 days. A low DPO implies that the business takes a shorter time to pay its trade creditors and vice versa.

Like DSO, DPO varies hugely by industry, and DPO trend is more important to analyze than actual DPO value. For example, if a business is trying to preserve its cash reserves to purchase new equipment, its month-on-month DPO value might rise because it is taking more time to pay its trade creditors.

Days Inventory Outstanding (DIO)

DIO measures the average number of days a business takes to convert its inventory into sales.

DIO is calculated based on average accounts inventory divided by cost of goods times 365 days. A low DIO implies that a business takes a shorter time to convert its inventory into sales and vice versa.

Like DSO and DPO, DIO varies hugely by industry, and DIO trend is more important to analyze than actual DIO value. In general, a lower DIO indicates that the business has good inventory management and vice versa.

Cash Conversion Cycle (CCC)

CCC measures the average number of days a business takes to convert its resources into cash flow. CCC is calculated based on the sum of DSO and DIO, less DPO. CCC evaluates operations and management efficiency because it provides stakeholders with insights as to how long the business takes to realize cash flow from its investments in sales and production processes. A lower CCC value usually indicates that the business is efficient in managing its operations and vice versa.

3. Managing Existing Credit Facilities

The use of borrowed capital helps a business grow and be profitable because it gives it the ability to manage short-term and long-term needs such as bolstering its cash reserves for future net working capital requirements and capital expenditure investments.

A business must not only build a strong rapport with its lenders but also regularly monitor all of its existing credit facilities to ensure full covenants compliance, match facilities to the purpose of the loan, manage debt maturities and obtain the best financing rates.

The Importance of Measuring and Managing Liquidity Risk

If business leaders don’t thoroughly understand liquidity risk sources and the principles of measuring and managing liquidity risk, insolvency risk skyrockets. Today’s unprecedented challenges have certainly underscored this. Any business with liquidity concerns should consider bringing in an experienced, objective consultant for a thorough liquidity risk evaluation before trouble escalates. An expert can help to get you back on course and provide a plan for keeping you there.

The COVID-19 pandemic has made liquidity a pressing issue for many businesses. If you need help measuring and managing liquidity risk, reach out to 8020 before a downward spiral has begun. You can also learn more about our cash flow forecasting services by downloading the resource below.

About the Author

Prior to joining 8020 Consulting, Joe was an Investment Banker with experience in capital and debt markets, M&A, IPO, credit, distressed assets, and financial assurance. His key responsibilities include buy-side and sell-side M&A, subsidiary spin-offs, capital raising through the debt and equity markets, structuring of hybrid securities, turnaround and restructuring, and due diligence support. Over the years, Joe has advised and raised capital for REITs, property developers, and major palm oil players. Joe has also lived and worked in a few of the world’s major financial cities such as Los Angeles, London, Singapore, and Hong Kong. Joe graduated from the University of Southern California, and he is a Chartered Accountant with the Institute of Chartered Accountants in England and Wales. Joe also holds the following FINRA licenses: Series 24, Series 63 and Series 79.

Scenario Analysis Example: Business Planning During the Pandemic

July 9, 2020 by 8020 Consulting

The COVID-19 pandemic has created unprecedented levels of uncertainty for almost all businesses. Business leaders are being pressured to make challenging decisions and implement changes swiftly in order to mitigate near-term risk and drive long-term continuity. However, before they can plan and implement effectively, these leaders must consider a range of possible scenarios. In this post, we’ll examine scenario analysis and walk through a very specific scenario analysis example that can serve as a guide to optimizing the process.

Some Initial Scenario Analysis Considerations

Unlike financial planning and analysis, which is often a single-point projection and scenario, scenario analysis is much more dynamic and robust. It provides business leaders with insights on various outcomes and assists them in planning and dealing with uncertainty.

Today’s circumstances and changing variables create a unique set of challenges for business leaders undertaking scenario analysis. With so many elements beyond their control, many critical questions simply don’t have clear and ready answers:

How long will this pandemic last?
How fast will the virus spread?
When will the economy fully open for business?
What is the overall impact on our demand?
What impact do the lockdown and work from home have on workforce productivity?
How have our customers been affected? In particular, what is the impact on their disposable incomes?
How do travel restrictions affect our suppliers and their ability to distribute goods and services?

What Scenarios Should Businesses Consider When Preparing a Forecast?

Business leaders should include at least three scenarios in their analysis, with different drivers and assumptions under each scenario that show the impact on revenue as well as on fixed and variable expenses. Based on the current business environment, our team recommends these scenarios:

Pre-COVID-19 Management Plan
Probable Case Based on Current Data
Worst Case

Before we dig into a specific scenario analysis example, let’s take a look at each of these three cases.

Pre-COVID-19 Management Plan

This should be the starting point of a (base line) scenario analysis that shows management’s current strategic forecast for the year under “business as usual” drivers and assumptions. Since a 2020 plan would already have been forecasted and finalized in 2019, this scenario excludes the impact and uncertainties caused by the ongoing pandemic, providing businesses with the “what it would have been” scenario.

Probable Case Based on Current Data Scenario

This is a best estimate of the future based on current data. In the current COVID-19 business environment, this scenario often reflects the assumption of an economic slowdown and reduction in revenue. However, there are several industries (e.g., tech companies with delivery services) that are expected to experience growth because of the pandemic and related lockdowns.

Within the COVID-19 “probable case” scenario, business leaders should further evaluate several possible outcomes that could result from actions taken by federal, state or local governments:

Social distancing rules will be relaxed in the near term, allowing a return to near term within 30 days.
Social distancing rules will be relaxed in the mid-term, allowing a return to near term within 30 – 90 days.
Social distancing rules will not be relaxed, preventing a return to near term for at least 90 – 120 days.

Worst Case Scenario

This scenario should reflect a sustained economic fallout and delay in economic recovery due to COVID-19 and how this disastrous situation would result in a perpetual revenue decline and accumulation of unforeseen expenses. In this case, the pandemic continues for several months or years until a vaccine is developed. Thoughtful scenario analysis and planning is particularly critical here so that business leaders can choose the best course of action to ensure their businesses can operate or even survive in such an adverse and unforgiving environment.

Beyond Basic Scenario Analysis

After evaluating the level of economic activity under each of these scenarios, business leaders need to examine assumptions and key business drivers for each as well. These assumptions and key business drivers could include:

Cash inflow: Growth and recovery assumptions, proceeds from the stimulus bill, sales of non-essential assets, debt and equity fundraising, recovery of account receivables, proceeds from new business opportunities arising from the crisis
Cash outflow: PTO/severance payments, contract renegotiations, amendments to trading terms, turnaround and restructuring services expenses

Businesses that are adversely impacted by COVID-19 should focus on cash preservation. Under all scenarios, a robust model will help business leaders understand their immediate liquidity needs and guide the creation of strategies to meet those needs. Ultimately, the real benefit of scenario analysis is that it reinforces awareness and encourages the identification and evaluation of potential actions indicated under all possible outcomes.

With that in mind, let’s now look at a specific scenario analysis example in Microsoft Excel.

Scenario Analysis Example: Setting Up in Microsoft Excel

You don’t need to be a Microsoft Excel guru to create a scenario analysis that will give you great insights into your business.

Below is a scenario analysis example that shows how a finance professional can use Excel to examine a company’s revenue (Line 13) forecast. Please note that this approach can be replicated for all other financial statement line items such as other income or cost of sales and expenses.

Step 1

As noted above, our team recommends creating these scenarios:

Pre-COVID-19 management plan (Line 5)
Probable case based on current data (Line 6)
Worst case (Line 7)

In our imaginary company, Company ABC, total revenue (Line 13) consists of the sales of two products, Product A and Product B.

Step 2

Company ABC’s management needs to evaluate what impact the COVID-19 crisis is expected to have under different scenarios.

For example, after deliberations, Company ABC’s management expects sale units and sale price of Product A under the probable case to remain stagnant (Line 22, 28), while under the worst case, sale units of Product A are expected to drastically decline (Line 23) and sale price is expected to remain unchanged (Line 29).

Step 3

Create an operating case selector (line 4) using the OFFSET Excel function.

Step 4

Under all our assumptions and drivers (i.e., units sold and sale price), create a “selected case” line (line 24, 30, 41, 47) that will extract the assumptions for the scenario selected in the selector toggle. This can be achieved using the OFFSET Excel function discussed in the above step.

Step 5

The total revenue (Line 13) is calculated based on the selected case’s drivers and assumptions. For example, under the probable case, total revenue is calculated based on the sum of units sold (Line 17, 34) multiplied by the sale price (Line 18, 35).

Excel Tip: It is best to use the OFFSET Excel function for scenarios when possible because OFFSET is very versatile for many purposes, can return cell range (i.e., array functions and graphs) and keep the source range of data dynamic.

If this scenario analysis example has made you want to conduct your own analysis, 8020 can help. One of our experienced consultants can ensure that your analysis is structured to reflect today’s challenging business environment and give you the strongest possible planning foundation. You can also learn more about our relevant services by downloading the guide below:

business stabilization and contingency planning

About the Author

Prior to joining 8020 Consulting, Joe was an Investment Banker with experience in capital and debt markets, M&A, IPO, credit, distressed assets and financial assurance. His key responsibilities include buy-side and sell-side M&A, subsidiary spin-offs, capital raising through the debt and equity markets, structuring of hybrid securities, turnaround and restructuring and due diligence support. Over the years, Joe has advised and raised capital for REITs, property developers and major palm oil players. Joe has also lived and worked in a few of the world’s major financial cities such as Los Angeles, London, Singapore and Hong Kong. Joe graduated from the University of Southern California, and he is Chartered Accountant with the Institute of Chartered Accountants in England and Wales. Joe also holds the following FINRA licenses: Series 24, Series 63 and Series 79.

5 Keys to Successful Headcount Planning

June 4, 2020 by 8020 Consulting

Headcount planning is more than simply finding bodies to fill seats. It’s strategic. It’s about ensuring your business can thrive. It’s having the right people in the right places to make that happen. Simply put, it’s one of the most impactful responsibilities your Human Resources (HR) department has, and yet:

According to PeopleFluent, 60% of HR leaders say headcount planning is one of their weakest links.

In the everyday world, headcount planning is tough. When you add the effects and uncertainties of a world responding to a pandemic, it can feel almost impossible. Good news is the best practices of headcount planning stand true in any world – but execution can be drastically different.

Now more than ever, timing is critical. We’ll all hopefully be returning to work very soon, and any business mired in its current, pandemic-reactive state could be left behind. The answer is looking forward – to think about the current state but also to plan for near- and long-term needs. To do that, businesses should follow these 5 keys to successful headcount planning:

#1 – Align with business strategy.

COVID-19 has drastically affected the strategies of many businesses. It’s safe to say that no one planned for a pandemic quite like this. That’s why headcount planning needs to be part of any strategic discussion. Successful leaders will create cross-functional war rooms that include HR. As these groups model best-to-worst impacts of the pandemic, HR representatives can ensure that headcount planning aligns with overall strategy.

#2 – Identify any skills gaps.

In a best-case scenario, your current employees can contribute to your war room planning. However, any shift in overall business strategy could create gaps in skills and expertise. For example, with supply chain disruptions, businesses may need to ramp up sourcing instead of continuous operations. Sourcing is drastically different than operations and requires a different skill set. HR must be able to identify and respond to gaps like these.

#3 – Allow managers to help identify and fill gaps.

Managers know their people. They’re in the trenches with them every day. They can help identify and respond to gaps by aligning employee strengths with current needs. HR should collaborate with department managers to help redefine roles and responsibilities. It’s easier than trying to hire, and this responsiveness helps in the short-term while providing a potential long-term solution for both the business and the current employee.

#4 – Hire the right candidates.

Even in a perfect world, hiring is necessary. When gaps can’t be filled with current staff, take time to determine headcount required from the outside talent pool. And don’t forget that today’s social distancing norms come with a unique set of challenges. Be sure your HR teams know how to assess candidates in a world of Zoom and FaceTime. Work closely with managers to identify the skills needed for new jobs. Don’t waste valuable time putting the wrong candidate through to an interview.

#5 – Project costs.

Once you know the job requirements for your organization and what resources are available internally versus what’s needed externally, you can start to project costs. It’s important to remember that hiring, onboarding and training might not be the same as they were pre-pandemic. Technology and IT are more important than ever before, meaning new and different costs could be lurking. Realize that post-pandemic cost crunches are inevitable. Ensure your HR team can change their processes to be more cost effective and nimble during hiring and training.

Headcount Planning for the Post-COVID World

From where people work to how people work – the world has changed. Businesses that can respond by fully integrating headcount planning into overall strategies will win. But why go it alone? Contact us here to learn how an 8020 Consultant can help, or download our service sheet below.

Cash Flow Management & Forecasting Q&A [Video]

June 3, 2020 by 8020 Consulting

In this video, 8020 Consulting’s David Lewis and Mitch Browne discuss the importance of cash flow management and forecasting, particularly in times of economic disruption and uncertainty. Watch to learn how good forecasts are built and leveraged—and how a bottoms-up approach can better inform executive decision-making.

We’ve posted the full discussion below along with the full audio, but if you’re in a rush, you can also skip through the playlist for shorter segments featuring key questions.

Watch the Video

Listen to the Recording

We’ve also included the transcript (with time stamps) below for convenience. Happy viewing, listening, and/or reading!

Introductions (00:00 – 02:10)

David Lewis: Alright, let’s get started. My name’s David Lewis. I’m here with my colleague, Mitch Browne. We are with 8020 Consulting, based here in Southern California.

Today’s topic is cash flow forecasting. Our view as a firm is that this is something that it’s almost impossible to pay too much attention to, especially in the current economic financing, lending and capital environment. Not to mention the more-than-modest amount of uncertainty about future economic prospects. We’re optimists in our company, but it’s still good to be prepared.

Just a brief background on Mitch Browne. He’s an MBA from Washington. He has a very nice blend of corporate and investment banking and securities in his background. He worked at Wells Fargo Securities as an Analyst Associate and Investment Banking. He worked at Yahoo as a Senior Financial Analyst in the Corporate Finance area. He worked at Hulu as a Finance Manager. And at AECOM, which is now about a $20-billion global engineering services firm, he built experience in sell-side investment banking, buy-side corporate development, and corporate financial planning and analysis. So, he’s an excellent authority on cash flow forecasting and the subject of forecasting in general.

He’s been with the company for a number of years, and many of his projects have been around forecasting capital requirements for emerging growth and technology companies. He’s done a lot of transaction support on the sell-side, in which cash flow forecasting was an important part of determining the working capital peg—a key point of negotiation in M&A transactions.

So, Mitch, welcome to our remote and virtual world.

Mitch Browne: Thank you, David. Always good to see you.

Deficiencies & Opportunities in Cash Flow Forecasting (02:11 – 03:22)

David: The first question people might be asking is, what might be wrong or deficient with the way that we’re doing cash flow forecasting and reporting today, versus what might be going on in the environment, and what I should be doing?

Mitch: Good question. I think there are two main reasons we might think of it differently now than we would have a couple of months ago. Traditionally, companies consistently look at the P&L performance, they sometimes look at their balance sheet and they only occasionally look at cash. And as a result, many companies have cash flow forecasting setups that are essentially afterthoughts or backed in two types of calculations. And we’ll talk a little bit about what we mean by cash flow forecasts at 8020.

But the other way it is significantly different today is that forecast we built only 8 – 10 weeks ago likely didn’t incorporate all the variables and toggles that we would consider today. What I mean by that is, there are certain things that companies are reacting to today, whether it’s a decline in sales or trying to control costs. And there are things that we would want to plan for and assume that we just wouldn’t have taken into consideration a couple of months ago.

About Ground-Up or Bottoms-Up Cash Flow Forecasting (03:23 – 07:47)

David: Alright. Mitch, I’ve heard you say a lot about the fact that if a company hasn’t done this already, due to the change in economic circumstances, most companies should be rebuilding their cash flow forecasts “from the ground up.” Why is that and what does that mean exactly?

Mitch: Sure, this varies from what people might traditionally do with an annual plan, which is talking about our cash flow planning, we do it at a weekly level, and it is starting at the bottoms-up. So instead of taking prior periods and adding a percentage or taking away a percentage, we go at the most granular level and build up expected cash receipts and disbursements. That can be large items like rent and payroll and understanding exactly when they’re going to come out of our bank accounts.

It also includes future events for expected expenses that we maybe didn’t really think about. Whether it’s annual maintenance of some assets, whether it’s some sort of cash payments for taxes, things like that. In general, we add those things that when you’re planning at a bigger scale, either a quarterly or annual view, you might not care when those values are going to hit.

What we’re talking about is a bottoms-up cash flow analysis that lets you know what your anticipated cash balance is going to be every given week.

David: Why do you think that’s important now?

Mitch: Well, simply, it’s important because you don’t want to run out of cash. This is a consideration that is a reality for some companies all the time, but for many companies, this might be their first time or at least first time in maybe a decade where they’re looking at cash balances. And they really want to know: where is that turning point? Where are they going to need to ensure they have additional financing lined up?

Additionally, and we’ve encountered this with our small startup or high-growth companies, it also can inform when you want to raise money. You don’t want to raise too much money and over-dilute existing shareholders. And so whether it’s trying to conserve cash or trying simply just to know when your next round of financing is necessary, and how much—those are both valid reasons that the company would want to revisit or create a cash flow forecast.

David: Okay, that makes sense to me. And, I know that, particularly in Los Angeles, there’s a very large number of companies that are venture-capital-backed that may have paths to profitability, but the path may run out a few years into the future.

And so in a different kind of a funding environment, they might need to shift gears in terms of their burn rates and maybe getting to profitability, or at least cash flow breakeven much more quickly, which could necessitate some dramatic changes at the enterprise or a change in their business model.

What kinds of companies would you say are good candidates for this type of forecast?

Mitch: Well, it’s anyone who’s looking at cash a lot harder and maybe looking at cash balances for the first time. And it can be tempting to look at your traditional forecast and traditional P&Ls and do a proxy for cash, but it really doesn’t give you that same level of certainty. I think going through the exercise of bottoms-up comprehensive cash flow forecasting can expose the drivers of your costs on a true cash basis as opposed to a P&L, which one can exclude some cash costs for whatever reasons.

It also really articulates what level of investment is required. Instead of spreading investments over a longer period of depreciation, you’re actually saying, “Oh, I need to go spend a million dollars on this physical item or this piece of software.” You can see where those bumps are, and understand which of those things are truly necessary or may be pushed out, delayed or spread out over a longer period of time.

And similarly, you can think about headcount, hiring as well. Companies that, like you said, might be smaller, high-growth companies may have had a certain path to profitability. If they know they’re going to need to make that cash last a little longer, they may need to revisit some of the things they’re planning to do the rest of the year.

Scenario Analysis and Changing to the Economic Conditions (07:48 – 09:50)

David: Okay, that makes sense. That’s a good point, in terms of making fixed asset investments or other things that get amortized over time. They may not look that consequential if you take them over their useful life and you’re just recognizing the expense every month. But that can be very significant cash outflow at a time your company should be looking at cash.

I believe it’s true that there are some very unusual things about the suddenness of the change in economic circumstances. And how it’s impacting companies operationally. And things that you would typically have extrapolated from an EBITDA forecast into a cash flow forecast today. There are risk areas, there may be opportunity areas, but there are certainly risk areas on the cash flow forecast that probably people were not thinking about two or three months ago.

You mentioned earlier in our discussion about some of the toggles and scenario analysis or input areas you’d like to have today that you might not have thought seriously about three or four months ago. Can you talk a little bit about what those are?

Mitch: Sure, there are some of the bigger-picture items. Maybe you’re thinking about expanding your footprint real estate-wise or making new hires—those are sort of the easier ones to wrap your head around. Those are maybe areas you to wait on or reduce.

A few of the areas that would be considered today that never would have crossed one’s mind perhaps eight or nine weeks ago would be things like furloughs or leaves of absence or having salary reductions across the board types of reductions. Even some relatively smaller things that no one may have thought of, like 401k matching contributions, or smaller areas of G&A overhead that in most traditional or typical budgeting processes don’t even come up as an option to toggle.

Incorporating Deterioration of Credit Quality (09:51 – 11:07)

David: That one makes sense. How do you integrate deterioration in credit quality of your customers? I’ve thought about that for clients in certain sectors, but can you talk a little bit about that and how you build that in your cash flow forecast?

Mitch: Yeah, that’s a great point really. In addition to the expense side, which does get a lot of the focus, is the receivables and collectibles. And so understanding is part of a cash flow forecast, we go at the creditor level and look at each amount owed to the company and owed out, and we work to be able to evaluate the likelihood of collecting and maybe revisit historical assumptions around bad debt.

If historically it was 3%, is that still a reasonable assumption? You really want to go account by account to understand the risk associated with each. The last thing you want to do is build out this cash flow forecast, assuming everything’s perfectly collected, and realize you haven’t really had a comprehensive approach and your data is not accurate. Because then you’re not going to collect the way you assumed you would have eight weeks ago.

Making the Case for Prioritizing Cash Flow Forecast Updates (11:08 – End)

David: So it could either be that you have business failures that are actually causing your write-offs to go up significantly—I mean by orders of magnitude—or you have a stretching out of payments, which obviously can come in cash. So all of a sudden, if you don’t have a revolving credit facility in place, now is not the best time to be going out looking for one. But I know that a lot of companies are drawing their facilities down so they have cash, part of which might be needed because even if their customers are paying them, they might be stretching out the payment terms beyond plan. So I think that makes sense.

Anything else in terms of thinking about the benefits of doing this exercise? Most of our people in finance, the CFOs and others that we know, generally are always trying to do more work than they really have the capacity to do. Most companies don’t exactly over-invest in the size of the accounting and finance team. If somebody is wondering what the benefits of doing this are versus the more urgent compliance and reporting and control requirements they have, what would you tell them about why cash flow forecasting is a worthwhile exercise?

Mitch: Good question. I think everything gets viewed with a certain level of urgency. And that’s only increased over the last couple of months.

If you’re asking me to defend a cash flow forecast, I’d say it’s probably the core analysis. What is the thing that keeps the light on? It’s cash, right? At the end of the day, that’s going to be as important, and I’d say probably more important, than any sort of traditional forecast or view on a prior period. Both of those are great to have, but you really do want to have a very certain idea of how long your cash is going to last and what your capital needs are. So obviously, it’s a little self-promotional, but I’d say put it at the top of the list.

David: I agree. It is self-promotional, but I think you’re right about that. Somebody once told me a long time ago, they said the number one rule in business is never run out of cash. It probably sounds obvious, but what I have found that, first of all, we know you can grow yourself right out of business if you’re not properly capitalized and financed.

The second thing is that, particularly in the middle market to lower-middle market, I think many companies don’t realize that you don’t want to wait to the last minute to find out that you need to go raise more cash. By that time, there are all kinds of bad things that can happen—including ending up losing operating or equity control of your enterprise to your lenders, for example.

It’s important to identify points in the future when cash might be at a premium well ahead of time. That’s one thing.

The other thing I would say is that one of the greatest gifts a CEO or CFO can have or give is the gift of peace of mind. I know that when we headed into this, one of the first things we did as a firm was build a very robust and dynamic cash flow forecast. So even though we don’t know with certainty how the economy is going to perform over the rest of the year, or how our business will perform, we’re quite confident we have a very long runway to operate, pivot the company if and as necessary and adjust the size of the enterprise if we need to do that.

It gave us the mental space to take the time to plan deliberately and let things play out. We were in a position from a financing cash perspective that we didn’t need to make any rash, deep or dramatic cuts in the organization. So that was good for us. And I think any company should have that. Because it tells you if you have a one-year planning or five-year planning horizon, but you’ve got six months of cash, that doesn’t work very well. So, I just think it’s a responsible thing.

One of the analogies you gave me—I know that you did a long project for a client of ours in the electric vehicle space—is that knowing exactly how much charge is left in your battery and how many miles that will get you is a lot better than wondering with some degree of imprecision. I think the same thing is true for an organization with regard to cash.

Did you want to add something else?

Mitch: I just wanted to add onto that. You made a comment that’s worth pointing out or re-highlighting. Getting this as early as possible is always better. Similar to the car example you just said, you want to know the news as early as possible because the longer you wait, the fewer options you have.

If you find out you have one week of cash left, there’s very little you can do. Your hands are going to be very forced as to what your possible remedies and actions are. The earlier you can find out that there is a potential crunch or problem, you’ll have a lot more flexibility for optimizing cash flow. You can make decisions that are good for the company in the long run, versus having to make last-minute drastic measures.

David: That is correct. Well, thank you Mitch, as always, it’s a pleasure to spend time with you. I hope that anybody watching this found it useful—and riveting in fact. With that, we’ll wish all of our listeners and watchers a great afternoon, evening or whatever the case may be.

Thank you, Mitch.

Mitch: Thanks David.

Learn More

We work with a variety of companies interested in getting more out of their cash flow forecasting tools. To learn more about cash flow forecasts, you can download our free guide below. If you’re interested in exploring working with us, you can also download our cash flow consulting services explainer. Thanks for reading!

What to Expect in Your 13-Week Cash Flow

May 28, 2020 by 8020 Consulting Resources

This checklist details attributes of best-in-class 13-week cash flow forecasts to help operating executives gauge the quality of their own forecasts.

13-week cash flow forecast guide call to action

How to Proactively Improve Operational Costs

May 14, 2020 by 8020 Consulting

We are living in an unprecedented era. The COVID-19 pandemic has forced many companies to rethink their liquidity risk, resulting in massive layoffs in an attempt to stay afloat. However, should it really take an adverse event to focus on cutting costs? Looking back, it’s likely that companies could have avoided massive layoffs if they had put an emphasis on creating and maintaining an efficient cost structure. So where does the problem lie, and how can companies improve operational costs and efficiency?

Optimize the Strategic Planning Phase

Typically, a company’s earnings are closely aligned with revenue. But any company should consider the impact on earnings if they also added a strong focus on improving the efficient use of capital and optimizing cash flow.

At the beginning of each operating year, a company’s executive team executes a strategic planning process that outlines the company’s goals / earnings for the upcoming year, as well as the next three to five years. When the business environment is conducive for growth, the focus tends to be on increasing revenue with less emphasis on optimizing the cost structure. This, in turn, may create supply chain inefficiencies, unbalanced labor productivity and sub-par inventory management.

Companies tend to set goals without mitigating risk and scenario analysis, such as decrease in planned revenue, increase in supplier costs, macroeconomic changes, etc. To alleviate earnings loss from a downturn, processes need to be built that enable a firm to respond efficiently.

Improve Operational Costs

To improve operational costs, define a process that measures the return value of every dollar spent. Here are a few items worth consideration:

Break Down of Fixed vs. Variable Costs: Understand the fixed cost structure, including contracts, and then increase / decrease variable costs as a function of change in sales dollars and/or units.
Headcount ROI: Align roles and responsibilities with strategic goals and measure return on investment. This will provide clear metrics to measure employee performance, decrease ambiguity and increase accountability. (Learn more in our blog: “5 Keys to Successful Headcount Planning“.)
Capital Investment: Define capital investment strategy, including metrics, such as hurdle rate / Internal rate of return (IRR) and continuously measure outcome to ensure that goals are realized.
Invest in Data / Analytical Capabilities: Build a robust demand planning process and measure cost throughout the supply chain. It is critical to identify and understand the starting baseline in order to improve that process.

Optimize Resources

Having worked as both an employee and a consultant, I have come to admire the freedom and the focused approach of a consultant. Companies often undertake cost improvement initiatives that do not deliver the desired goals due to personal interests or biases, lack of knowledge of industry best practices, and over-stretched employees concurrently working on their regular jobs.

Because cost optimization initiatives invariably create friction, they are best handled firmly, yet delicately, and without fear of repercussions. Consultants are integral in bringing leadership, breaking down barriers, implementing changes (process and/or systems), possessing cutting-edge knowledge and focusing on results.

If you’re facing adversity, it may be more prudent to bring an outside perspective to shake the trees and implement process improvements or new processes. Every downturn is an opportunity to get leaner and be prepared for upcoming challenges.

Skimming? Here’s a summary.

A company looking to proactively improve operations can weather the storm and streamline costs by:

Incorporating various scenarios into strategic planning
Aligning headcount with strategic goals and creating accountability
Building infrastructure / analytical capabilities
Measuring every data point in the supply chain
Investing in learning and implementing industry best practices
Creating an internal culture where everyone understands the value of every dollar saved

Efficient growth requires discipline and creates a snowball effect on a company’s earnings. It tremendously improves a company’s ability to handle adversity. Problems are easier to identify and alternative solutions and practices are even faster to implement.

Don’t wait for the next crisis or pandemic to improve business processes. Proactively plan for business disruptions and economic changes. As the saying goes, “Fortune favors the prepared mind.”

More on Business Stabilization and Contingency Planning

If you’d like to learn more about how to improve operational costs, and as you build strategies for post-pandemic, download our guide to business stabilization:

KPIs & Scenario Planning: Tracking the Right Business Metrics for Modeling

May 12, 2020 by Carol Lee

The impact of COVID-19 has challenged business leaders with continuing to protect the health of their employees and businesses while adapting to a “new normal” of working. In the midst of economic challenges and uncertainty, leaders must reclaim control from unprecedented headwinds while discovering new ways to thrive. It is vital for leaders to develop KPIs and scenario planning methods to successfully adapt to the rapidly changing business environment and deal with the uncertainties that have been brought upon through the COVID-19 crisis.

As the economy reopens and businesses pave their way to recovery, leaders will need to develop dynamic strategic responses to stabilize and then grow. It is critical to balance a response to near-term headwinds while maintaining a long-term focus. Here are thoughts on how to focus on the right KPIs and scenario planning components to create that balance.

Top Scenario Planning Components

Now, more than ever, it is important to develop business plans based on scenarios that are tailored to your company. Here are some items to consider during planning:

Identify the uncertainties and assign a range of potential outcomes.
- External factors include the timing of the economy’s reopening, the pace of an economic rebound and government interventions.
- Internal factors include cost reduction initiatives, workforce changes, supply chain initiatives, etc.
Identify key variables that will affect revenue, costs, operations and cash flow assumptions and design responses to various “fire drills” that may occur under different scenarios.
Use this period of difficulty to reexamine success from a strategic planning perspective, both near-term and long-term.

Reassess Current KPIs and Business Metrics

Crises make it difficult to predict what will come next and upend business as usual. It is likely that some of the traditional measures leveraged pre-Coronavirus are now less relevant or lower priority.

Identify and track only the key metrics that will directly impact the scenarios you have outlined and have the highest potential bearing on your business.
Keep the list short and simple so that your organization can remain focused and in control. The brevity of the list will allow for quickly tackling and communicating issues as they arise.

Key Scenario Planning Metrics in a Crisis like COVID-19

Business leaders need full visibility into certain metrics to prioritize and respond quickly and effectively. Listed below are examples of financial, operational, cash management metrics that are most relevant in this new COVID-19 landscape.

How will you maintain a productive workforce while prioritizing health?

% workforce by COVID-19 risk exposure level and location
Employee performance and productivity as workplace setups have changed
Employee surveys, including effectiveness of communication and employee wellness

What are your customers’ needs and concerns?

Issues log to address immediate concerns
Customer readiness to restart and assistance needed

How will you manage your cash flow in the near term?

Daily or weekly cash inflows and outflows
Weekly cash flow forecast
POs in a queue prior to commitments
Vendor payments prior to release
Cash collection at risk and customers slow to pay

What is in your sales queue?

Weekly sales and volume
Sales Pipeline
Pricing changes
Sales risks

How will you balance the current level of inventory on hand and demand as you resume business?

Weekly inventory on-hand for critical parts
Demand forecast to restart
Supplier readiness to restart and lead time needed

How has COVID-19 impacted manufacturing operations?

Yield trend
Factory utilization trend

Then take a deeper look at COVID-19-related expenses.

What is temporary and what will be the new normal for the future of work?

Next Steps and Using Scenario Planning to Look Ahead

Given the rapidly evolving external factors, closely monitor leading macroeconomic indicators, including trade policies that are specific to your industry. Track how your business is trending relative to evolving changes in timelines impacted by broader regulations.

Although we are facing unprecedented times and scenarios, these metrics will provide guidance around time, cost and resources, and raise immediate issues for leadership teams to make the informed decisions and prioritize executional steps.

If you’d like to learn more about financial planning & analysis in a time of crisis, then we recommend you explore our guide to business stabilization, which linked in the image below.

It explores the manner in which we’ve been working with clients, including updating forecasts and assumptions and developing scenario planning. It also covers the importance of KPIs and streamlined management reporting, and it’s free to download:

About the Author

Carol has extensive experience in finance, accounting, strategic planning, financial modeling, transactional due diligence support, corporate restructuring, contract negotiations & administration, business development and operations. Her industry expertise covers healthcare, manufacturing, aerospace, bio-tech and entertainment companies ranging from start-up to the Fortune 500. Prior to 8020, she held Controller and Finance Leadership positions at companies including, ITT, SmithKline Beecham and Quest Diagnostics, Paramount Pictures, Quallion LLC and Catalytic Solutions. She is a six sigma greenbelt and successfully led various cost savings initiatives in inventory controls, process improvements, financial system integrations as well as cash flow projections and controls. She holds a BA in Economics from UCLA and an MBA from Pepperdine University.

Capitalizing on Zero Interest Rates and Restructuring Debt Obligations

May 7, 2020 by Tennille Wilkinson

Many corporations have implemented remote working arrangements and have either significantly scaled back or completely halted operations. Layoffs have been widespread, and the economy is under tremendous pressure. With revenues declining or eliminated, corporations with substantial debt obligations are faced with the challenge of meeting debt payments—and are exploring options for restructuring debt. But stresses in credit markets may create a wave of defaults and liquidity issues that ripple across investment markets.

While a sharp recession appears to be unavoidable, policymakers can take steps to cushion the blow. Congress has authorized relief payments to both businesses and individuals while the Federal Reserve (Fed) has promised to provide financial support with trillions of dollars in emergency lending. In a bold move, the Fed has cut its benchmark interest rate to zero in order to bolster the economy. In addition to cutting interest rates, the Fed announced in mid-April that it would buy at least $700 billion in government and mortgage-related bonds as part of a wide-ranging emergency action to protect the economy from the impact of the Coronavirus outbreak outbreak.

These strategies aim to prompt lenders to extend financing, while investors pile into government bonds, which results in lower yields. Now, more than ever, it is cheaper to borrow money or refinance existing debt obligations. This eases the financial burden many companies now face by freeing up cash through debt restructuring techniques. These techniques can lower interest repayments on refinanced current debt and access to new low-interest funding, so that they may retain their core workforce and stay afloat through the peak of the pandemic.

In times of severe economic downturn, creditors are often in support of debt restructuring because they understand they would receive less should the company be forced into bankruptcy and/or liquidation.

Six Alternatives to Restructuring Debt

1. Refinance Existing Borrowings at These Lower Market Rates

Lower interest payments free up cash for alternative essential uses.

2. Extending the Maturity of Existing Debt, Thereby Lowering the Future Recurring Payment Amount

This option can be combined with an interest rate refinance (point 1 above).

3. Debt/Equity Exchange

This occurs when creditors agree to cancel a portion or all of their outstanding debts in exchange for equity in the company. The swap is usually a preferred option when the debt and assets in the company are very significant, so forcing it into bankruptcy would not be ideal.

The creditors would rather take control of the distressed company as a going concern. Again, a company considering this option will have to consider the impact of ownership dilution and gaining support of current shareholders.

4. New Borrowings at Low Interest Rates

Companies may need to assess their current leverage ratios (debt/equity and debt/assets), as well as restrictions on borrowings, to determine their capacity for new borrowings and the trade-off between taking on new debt and the benefit of being able to pay unavoidable expenses.

5. Issue Callable Bonds

A company will often issue callable bonds to protect itself from a situation in which interest payments cannot be made. A bond with a callable feature can be redeemed early by the issuer in times of decreasing interest rates. Callable bonds have a higher interest rate than non-cancelable bonds, but callable bonds allow the issuer to readily restructure debt in the future because the existing debt can be replaced with new debt at a lower interest rate.

6. Issuing Equity Instead of Taking on New Borrowings

Equity may be a cheaper option in the short term (no mandatory payments, depending on the type of equity issued), and proceeds from equity issuance may be utilized in paying down high interest debt. However, potential ownership dilution is an important consideration and may not pass shareholder approval. Secondly, the current aversion of investors to companies threatened by coronavirus make equity a less favorable option. One of the safest investor strategies, and the most extreme, is for investors to sell all of their investments and either hold cash or invest the proceeds into much more stable financial instruments, such as short-term government bonds and treasury bills (as opposed to corporate stocks). By doing this, an investor can reduce their exposure to the stock market and minimize the effects of the raging bear.

Final Thoughts

While several alternatives have been outlined above, at the very least, refinancing of their current interest rates should be considered. This extends beyond refinancing long term debt obligations and includes leases and credit card rates.

Debt restructuring provides a less expensive alternative to bankruptcy when a company or country is in financial turmoil. It’s a process through which an entity can receive debt forgiveness and debt rescheduling to avoid foreclosure or liquidation of assets.

8020 Consulting can help with the process if you need support. You can learn more by contacting us or exploring our finance and accounting optimization services:

Return to Work Planning for Accounting and Finance

May 5, 2020 by 8020 Consulting

This has been, to put it mildly, an interesting first quarter. We are facing challenges and disruptions on a global level that affect almost every aspect of our lives. Everyone has had to adapt in order to function during this time. Businesses are no different. Some very hard decisions have had to be made, and now, companies are wading into return to work planning.

Unfortunately, we are not out of the woods yet. Hopefully, we will continue to make progress and move back to normal (or a “new normal”) as safely and expediently as possible. Eventually, all stay-at-home orders, face mask restrictions, and other safety measures enacted to lessen the spread of COVID-19 will be lifted and life will go back to a new normal. Businesses will open back up, children will go back to school, and workers will go back to work. (Though where they will be working from may be up for discussion.)

Depending on the type of business, this return could look drastically different from before the restrictions were put in place. Companies are coordinating across all functions and departments to apply what we have learned from this pandemic. Accounting and Finance teams play a big role in this coordination. Below are some items to think about when preparing a “Return to Work” plan.

Close Calendar Adjustments

Accounting departments within companies take pride in shortening or having a short “close-window.” What this usually means is that the accounting team works a little extra right after month-end close for a few days to complete all the required tasks. This leads to a less stressful rest of the month and a turnaround that makes the C-level happy. This time before companies return to work is the perfect time to implement close calendar changes that could either shorten the close-window and/or reduce the stress on the accounting team.

Are there items in your close calendar that can be moved to before or after the close period? Now is the time to identify those tasks that do not provide maximum value/return to the company‘s close process. Use that time to spend on more valued activities or to shorten the close-window.

For example, many companies perform balance sheet reconciliations during close to review monthly activity and perform an account variance analysis. Reviewing your chart of accounts and assigning a Balance-Level based on materiality (High, Medium, or Low) and Risk-Level (High, Medium, or Low) could identify account reconciliations (Low balance and Low risk) that could be shifted to the post-close calendar or to a quarterly or semi-annual reconciliation. Performing a high-level variance analysis (account balance-only) against the prior period in tandem is an easy way to identify any account balances that had a sudden spike in activity and would prevent it from being missed.

Standardization is also a wonderful way to reduce stress and time spent on the close. If your company has suspended operations during this time, use this opportunity to clean up your folder structure to make things easier to find. Create standardized forms, combine duplicative Excel workbooks, add macros to existing Excel files to automate tasks – all of these can be done relatively easily and will shave off time of your close.

Work-From-Home / Work-From-Office Equation

There is a real possibility that the return to normal will be a gradual or stair-step process. Even without a government mandate, companies may still find it useful to stagger their return policy. Finance and accounting teams can use this time to come up with different plans to implement based on different return-to-work paths. These plans can and should be revised as new information is provided.

One activity that may prove useful is to review the finance/accounting functions to determine which of those require, or are maximized by, in-office attendance or collaboration. These vital in-office functions could then be scheduled to specific times in order to achieve the best results without adding complexity. They could be partnered with the company’s return policy, such as work-from-home days, staggered in-office work hours (arrival/departure times to/from work), limiting staff meeting sizes/time limits, and any other changes to ease the transition. These policy changes could be temporary, or if they prove to be effective and efficient, made permanent.

Planning for the Future

In addition to implementing changes now that can affect the immediate future, Finance teams should be working in coordination with HR to account for any company changes that will affect the budgeting process or budgeting assumptions well-before those budgets are needed. There could be changes that affect the rolling forecast, the budget for the upcoming year, or the 5-year forecast. Some items to consider are:

Is there a change to the floorplan (such as social distancing at work) that will require an update to the Cap-Ex budget? Will more cubicles need to be built and accounted for?
Will the company be leasing more office space to achieve a safer work environment?
If shared costs are allocated based on square footage, will these allocation formulas need to be updated or revised?
If the company decides to adopt a flexible work-from-home schedule, how will this affect the budgeting process? (e.g., Will rent costs be lower as less office space is needed?)

There are many ways that our return to “normal” could happen. Preparing for as many of these paths as possible before they are needed is essential to lessening any confusion, downtime, or surprises that may occur along the way. Finance and Accounting teams can also use this as an opportunity to revise or reconfigure their existing policies and procedures. Adjustments will be needed to successfully navigate the changing landscape. Good ones will allow you to focus on your business instead of your process. The best ones will redefine how your company operates efficiently and effectively.

We Can Help

If you’d like some support in planning, we have a team of 100+ consultants that are able to work remotely across California. You can learn about the type of work we’re performing in the pandemic by clicking on the image below, or you can also contact us to start a conversation.

Optimizing Cash Flow in Challenging Economic Times

May 1, 2020 by John Woolard

In turbulent and uncertain economic times, it becomes important to fully understand and forecast your company’s cash flow. We’ve offered thoughts into how to build cash flow forecasts in past posts, but it’s equally as important to take actions toward optimizing cash flow. You can also put good practices in place that will preserve working capital for not only today’s economic times, but well into the future. In this post, let’s review some actions you can take today to optimize cash flow in challenging times.

Establish your cash flow picture, and keep it updated on a weekly basis.

Develop a rolling 13-week cash flow forecast capturing all the cash inflows and outflows of your business on a weekly basis and keep it updated. Having a 13-week look into your cash flow will help you anticipate any cash shortfalls and will give you time to plan ahead. There’s also an additional benefit of preparing the forecast in that it helps you learn your business and see the cash flow ramifications of your business decisions.

It’s okay to keep an annual cash flow forecast, but beyond 13 weeks, the annual forecast tends to be more inaccurate. Best practice companies maintain both, and they are hyper focused on the rolling 13-week forecast for planning purposes. The best data points to use to establish the initial 13-week cash flow forecast are the recent actual cash flow history over the past few months. This can be gathered from the accounting system or from bank information. Payroll and facility costs are very projectable as to timing and amounts. Having a good understanding of contractual obligations and customer payment history will also ensure a more accurate forecast. Generally, the Controller or CFO will own the cash flow forecast and ensure that it is kept current.

No matter what your cash flow forecast projects, there is always room for improvement and optimization.

Want to know what should go into a 13-week cash flow forecast? Download our free guide:

Take some steps toward optimizing cash flow.

Here are 12 ways that you can work to increase cash flow in a tough economic climate:

1. Increase your communication with your key customers.

Check in on a weekly basis especially if the customer has past due balances. Consider having the CFO or other leadership team members reach out to their counterparts at the customer, establish a relationship and follow up on open receivables as necessary. Many times, having a senior management member involved will lead to quicker payments.

2. Establish goals for your accounting department to keep accounts receivables as current as possible.

Set what percentages are acceptable in the various aging buckets (e.g., current, past due categories) and manage accordingly. For example, the goal could be 80% of receivables in the current bucket and only 20% past due. Perform a weekly review with the accounting team to track progress against the stated goals. The more attention and focus you put on this usually leads to better results.

3. Establish an early-pay discount program to encourage faster payments.

Terms such as a 2% discount on 10-day payments is a good example of this type of discount. This could be designed as a short-term policy during the uncertain economic times and decided at a later date whether to continue into the future.

4. Start requiring cash deposits or pre-payments on certain types of longer-term or larger sales orders.

Many companies do not require cash payments upfront during longer-term sales or manufacturing cycles, and they should consider doing so. You can possibly be flexible on pricing or other margin concessions in order to help implement this with customers.

5. Get your customer invoices out fast.

Do a walk-through of your invoicing process to make sure there are no hidden bottlenecks or other delays. Review your systems to make sure they are being utilized to the fullest and that there are no delays due to manual processes or breakdowns in communications between internal departments.

6. Be aware of scope creep or additional services that could be billed to customers.

Many customer projects (based on industry) have additional work that ends up being performed (for free at times) that was not outlined in the contract or considered at the point of sale. This additional work could present opportunities to bill for additional services in the form of change orders which could increase revenue and cash flow.

7. Consider invoice factoring.

Invoice factoring is the process where you sell your unpaid customer invoices to a third-party factor. I would not recommend this step unless you are in immediate need of quick cash as the cost or discount given to the factor is relatively high. However, given the need for cash and the situation this could be an option to pursue on occasion.

8. Consider selling off older or idle equipment.

Older, unused equipment takes up space and can be converted to cash. Many tech departments will have a larger inventory of older servers or unused computer equipment. Manufacturing facilities will have equipment that is no longer useful or used efficiently.

9. Clean up your inventory.

Slow moving or obsolete items can be sold at a discount in order to generate cash flow. Analyze the profitability of your products and stop selling lower margin products and loss leaders if possible. Every business usually has a lower performing or losing product offering that can be eliminated.

10. Consider leasing versus buying.

Leasing, while more expensive in the long run, in many cases will have a more positive cash flow impact in the short or more immediate term. Cash and working capital can be preserved until the economic environment is clearer. Items in the technology arena such as servers or laptops or heavy machinery on the factory floor can all be leased versus purchased. Monthly payments will be a fraction of the cost to buy.

11. Renegotiate your payment terms and pricing with key vendors.

It’s a good idea to divide up your vendors between strategic and one-off. For the strategic vendors, work out new payments plans and terms. Don’t be afraid to ask or try as many vendors are willing to work with you as they need your business as much as you need theirs. Many landlords will also be willing to work with you if you are unable to pay your rent on time.

12. Do not pay bills early.

Make sure you are taking advantage of full payment terms. Bills should be paid on their due dates and not any earlier. Check with your accounting department and review your vendor payment history and identify if there are any early pays or opportunities to delay payments further.

Final Thoughts on Optimizing Cash Flow

Hopefully the above actions provide some ideas for optimizing cash flow in the immediate term. In addition, a complete drill down into the profitability of your business is recommended. It’s important to know:

What is the profitability of your products?
Is profitability optimized?
Is your labor efficiently used and is there an opportunity to streamline?

8020 Consulting excels at helping businesses answer those questions and can provide the analysis and data for you to make your business more profitable and streamline your cash flows. We can work with you and your team or do all the work for you. Our cash flow consulting experts have successfully performed all of the improvement actions listed above as well as business and product level profitability optimizations with many of our clients. We would be glad to do it for you and your business too. You can learn more about our services below:

About the Author

John is an Alumnus of Arthur Anderson and a CPA with over 25 years of diverse, hands-on financial and operational leadership experience in entertainment, technology, retail and distribution environments, including CFO, VP of Finance, and Controllership roles at companies ranging in size from early start-up through middle market as well as Fortune 500. John also has strong international management experience with time spent in the UK, Germany, India, and the Middle East. In fact, he managed global operations teams including the formation and expansion of India offshore operations and expansion of a company into the European market. Across his career, John has worked very closely with VC firms in the raising of multiple rounds of financing and negotiation of lines of credit with banks and he has helped lead companies through the successful exit / sale process.

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