It is possible that a business can still be reporting earnings but have trouble meeting its current obligations to both lenders and key creditors. Problems may develop as customers become slower to pay or, in some instances, don't pay at all. Problems may not be immediately recognised and could include changes in product/service demands, increasing overhead costs, use of obsolete production methods or increasing competition — some of these directly attributable to the decreasing economic climate. As a starting point, defer and/or eliminate all non-essential expenses and capital projects, where possible. Identify whether there are any current commitments that can be put on hold or adjusted given the current environment. Further, accelerate receivable collections: Focus on customers that normally pay on time and have started to slow payments; offer discounts to pay now; keep on top of even smaller accounts. Cash must be closely monitored on both a short-and long-term basis.
Short-Term Cashflow Forecast
Prepare a 13-week cashflow forecast. This is often an eye-opening exercise and will effectively capture most companies' business cycles. The forecast will help navigate choppy waters in the near-term, as it will highlight shortfalls in needed cash balances and/or show borrowing requirements that fall short of actual borrowing availability from lines of credit. You will need to ensure that any forecast is subject to revisions in light of Coronavirus and the ongoing impact it has on the market. Cashflow forecasting is a very popular tool used with distressed businesses and can be helpful for entities going through a rough patch or for stronger businesses struggling in this economy. Maintaining an up to date forecast will allow you to be able to easily identify if there is an upcoming risk of the business running out of cash. Being in a position to be able to identify when this may happen, puts you on the front foot for being able to make arrangements to source more capital or to organise payment arrangements i.e. contact with your bank for extended loan facilities, contact with Inland Revenue to arrange payment plans and liaise with landlords to determine whether a rent relief period is feasible.
A cashflow forecast will force you to take a closer look at all expected receipts and disbursements on a weekly basis and compare it to actual results. This way you will know right away if there is a collection issue with customers that needs to be addressed or if expenses are too high against expectations.
It will keep you abreast of how well the receivables are being collected on a short-term basis. In preparing the budget, be careful to select proper revenue assumptions (e.g., realistic sales, margins and/or receivable realisation), Be conservative in projecting revenues and cash receipts. On the disbursement side, control over inventory procurement and subsequent payments can be critical, as it is often the largest cash expenditure. Also, be sure to identify non-income statement items (e.g., payment for capital expenditures, loan principal, capita] lease principal obligations and/or interest) and nonrecurring items.
Factors to consider in developing a cash flow forecast include:
- Significant increases in the inventory balance could mean a business has too much cash tied up in working capital and that sales are shrinking or the wrong mix of goods exists.
- A drop in historical inventory levels could indicate that a company lacks sufficient capital to procure goods required to run its business. Further, the business could be experiencing issues with receiving key goods and services from overseas which are required to increase their inventory level.
We encourage businesses to keep in regular contact with their suppliers to ensure they are fully aware of any possible delays and what impact these delays may have on the business. Are there any areas of risk in the business’s supply chain?
- Significant increase in accounts receivable, without a corresponding increase in sales, can be indicative of a business that is having difficulty collecting on its receivables.
- We suggest businesses conduct a regular review of their debtors and identify if any debtors are financially vulnerable to COVID-19. Contingency plans should be formed should any debtors be unable to pay or are placed into formal insolvency.
- A drop in accounts receivable may be reflective of a drop in sales or demand for a business’s goods/services.
- Significant increases in accounts payable can be an indicator that a business is having difficulty paying its trade obligations on time.
- An increase in the amount of debt used to leverage the business versus historical levels is a sign that a business may be unable to operate its business using operating cash flows.
- A decline in property, plant and equipment may indicate that a business has not been making the appropriate amount of capital expenditures to maintain expected sales or production levels or to keep up with competitors.
- Additional capital infusions (e.g., second lien loans, bridge loans, etc.), although not necessarily a sign of financial distress, may be indicative of a business that is experiencing liquidity issues or cashflow problems.
Long-Term Business Plan (1-5 years)
This plan, in addition to the cashflow statement, should also include a full income statement and balance sheet. Prepare this using a bottom-up approach. This means going to the divisional or cost-centre level to derive estimates for revenue and expenses. For example, a business plan for a retailer should be derived on a store-by-store basis for both revenue and store expenses, and corporate overhead should be derived on a cost-centre basis. In a manufacturing business, revenues and expenses should be estimated for each major product line.
In all types of businesses, the assumptions and initial estimates should be compared periodically against actual results to determine whether they are reasonable. In addition, outside influences should be addressed, such as the current economic environment, backlog of orders, discussions with buyers and customers, and whether trends are in line with the industry and competition.
Businesses should be constantly assessing the market environment and be working to identify how they can adapt to the overcome any threats identified (i.e. flexible working). Following the Government’s economic response to COVID- 19, if businesses are experiencing cashflow issues, we encourage companies to review the three packages offered by the government to determine whether any relief can be provided and to contact their finance provider to determine what support can be provided by them also. These Government packages available are discussed further below.
Some additional items to think about when preparing a long-term business plan include:
- What factors (internal or external) caused the financial problems, and are they temporary or permanent?
- What direction should this business take (e.g., grow, stabilise, sell off non-core assets, etc.)?
- What products/businesses are most profitable and which customers are more profitable to the company?
- What are the strengths and weaknesses of the company (e.g., management, markets, industry, competition, etc.)?
- What assets should be liquidated or expanded?
- What amount of funding is necessary to implement the business plan?
- What commitments need to be maintained by the company and which can be deferred for a period of time?
- What employment issues may arise in the near future (i.e. health & safety), is there too much capacity within the company?
Preparation of sound business plans, both long and short-term, can provide you with renewed confidence during times of economic stress.