- Many companies are experiencing operational disruptions and reductions in demand.
- Finance leaders must alleviate urgent, unanticipated pressure on working capital lines and liquidity.
- By understanding your current liquidity profile and forecasting future needs, you can preserve cash in the short term while positioning your company for new growth.
“Cash is king.” We’ve all heard the saying, but it’s taken on new meaning as of late.
Three-quarters of more than 300 CFOs taking part in PwC’s April 2020 CFO Pulse Survey cited financial impact of the coronavirus, including effects on results of operations, future periods and liquidity and capital resources, as their top concern. So it’s no surprise that a poll launched by CFO Research around the same time shows CFOs taking action to preserve cash: 50% of the finance executives surveyed said their organizations are scaling back or delaying investments, 47% are working on improving their liquidity positions and nearly 20% are shutting down or idling some operations.
Looking to the future, keeping a tight handle on cash and liquidity is paramount. However, that’s easier said than done. In this piece, we have advice on analyzing current liquidity status, estimating future cash needs and freeing up working capital internally.
First, the basics: What exactly is your cash position right now?
To answer this question, you need visibility into assets and liabilities. From an assets perspective, you’re looking for the aggregate of cash, cash equivalents, prepaid expenses, marketable securities, accounts receivable, inventory and long-term assets. In terms of liabilities, accounts payable, debt, loans, notes payable, utilities, taxes, rent, wages and customer prepayment all need to be considered.
In this exercise, current, as opposed to noncurrent, assets and liquidities take precedence. It’s important for finance leaders to understand what assets are currently liquid or could be easily converted to cash in the next year. Current liabilities need to be assessed to determine what is owed in the next year and what will impact liquidity presently.
This is no time for guesstimates. Kane Polakoff, national practice leader for client accounting advisory service at international CPA and advisory firm UHY LLP, emphasizes the importance of near-real-time visibility into the numbers. Polakoff says that starts with timely and accurate financial statements and data.
“So, for example, some companies took 25 to 30 days to close the books,” he says. “Now, you’re already looking at data that’s outdated.”
Having timely and accurate numbers means leaders can project their own realities in light of rapidly changing industry trends and make more informed decisions.
Once you update the balance sheet to reflect current cash position, you have a liquidity snapshot to dictate future actions.
Needs & Wants
To project your company’s working capital needs, Rob Stephens, founder of financial consultancy CFO Perspective, recommends running the numbers.
“The most effective way to assess your cash needs is to prepare a cash flow projection,” says Stephens. “List your future cash inflows and outflows by week or month. If your cash is really tight, project daily cash flows. Calculate your ending cash balance at the end of each week or month.”
This exercise will predict when cash balances may dip below an acceptable level.
“A cash projection gives you time,” says Stephens. “The more time you have to make adjustments, the more adjustment options you have.”
Financial scenario planning will come into play to ensure that the company is prepared for multiple potential outcomes. Running scenario analyses on revised forecasts will help CFOs understand how operational disruptions may affect liquidity.
“Once you have a projection for the most likely scenario, run at least one additional scenario that delays or eliminates some of your cash outflows,” says Stephens. “These scenarios may show you need more cash than your most likely scenario is saying. Err on the side of caution, and hold more cash due to today’s economic uncertainty.”
Generally, the burn rate method is used by VC firms to gauge the speed at which a startup is spending its venture capital. However, in situations where a company is experiencing operational disruptions, like reductions in demand, unavailable inventories, an increase in days sales outstanding and failing supply chains, it can be an option to evaluate cash needs.
“It’s the amount of your cash outflows less any cash inflows,” says Stephens. “You can calculate your burn rate in terms of the cash you [will likely] spend per day, week, or month”
The most conservative way to calculate burn rate is to exclude all cash inflows, or include only the most certain income.
“You then divide your cash balance by your burn rate,” he says. “You measure cash in days, not dollars, when your bank balance is low.”
Once a company tentatively determines its resources on hand and future cash needs, now comes the important element: What internal actions can finance teams take to lessen the strain on working capital?
9 Tactics to Bolster Liquidity
External sources — like lines of credit, the bond market, inventory/receivables factoring, venture debt, government relief programs and private equity — are all viable options to raise capital. However, prospective funders will expect you to have already done what you can to preserve cash by identifying “quick win,” self-help measures.
Cost cutting and delaying expenditures are the main ways CFOs can rapidly shore up existing liquidity, given that current and projected business impacts, like revenue losses, reduced workforce utilization and portfolio imbalances, require companies to cut costs to match their performance.
However, be ready to bounce back rapidly when conditions improve. The goal is a calculated “right-sizing” undertaking.
Labor: Labor is usually one of, if not the, top expenses a company faces, and thus layoffs are often at the top of the cost-cutting agenda. However, there are alternatives, such as cutting hours or furloughs. Some companies are even offering voluntary leave without pay to preserve cash, since many employees need to provide child or elder care at home now. Furloughing, as opposed to laying off, allows employers to continue providing benefits, like health insurance, eliminating the tedious task of stopping and starting benefits and making it much simpler to bring employees back when business picks up.
Many companies have reduced contract labor and redistributed that work to permanent employees. In fact, nearly half of executives surveyed in a recent Brainyard survey cited the intent to eliminate contract workers and offer unpaid leave for permanent employees.
Note that if you take a PPP loan, you will not be eligible for loan forgiveness if you decrease the size of your workforce.
Salaries: Temporarily reducing salaries based on ranges, with the lowest-paid workers losing less than executives, can stave off the need for layoffs while preserving cash. Companies may also want to consider freezing pay and limiting or eliminating bonuses.
Marketing: When cost cutting, the marketing budget is prone to a paring down. According to Harvard Business Review, this could be the time to cut some “sacred cow” marketing programs.Instead of big investments in events, branding and major ad campaigns, many companies are finding it more economical and, in many cases, more effective to focus on lower-cost digital options to engage consumers and build brand awareness. Think social media or email marketing. Creating content that attracts visitors by providing helpful advice can also be more cost effective than other marketing channels if managed using SEO best practices. These tools can connect your company more directly with customers by communicating an empathetic, humanized marketing message.
The likelihood of bringing in new customers varies wildly based on industry and market. Some firms are finding that demand has increased, and money would be well spent on customer acquisition. Others may prioritize retaining current customers. CFOs should work with line-of-business leaders to assess the situation and allocate resources appropriately — and question those sacred cows.
Variable costs: Considering probable operational disruptions and reductions in demand, there are bound to be costs that can be reduced. Many variable expenses, such as travel, entertainment and dining, have likely already been eliminated — over 90% of executives in the Brainyard survey had cancelled all business travel. A drop in demand means that companies can likely reduce order sizes from suppliers or ask for extended terms. Implementing hiring freezes, cutting back on sales expenses and placing restrictions on training are other easily reversible ways to curb costs.
Activities: Company activities, notably capital projects, warrant an intensive review to determine which can be eliminated, put on hold or scaled back. Are there activities rendered unnecessary due to a shift in business demand? Can some be reassessed to run leaner? In situations with long-term contracts, are there related activities that can be scaled down? Determine what initiatives are critical to your customers and revenue base, and allocate resources accordingly.
Companies will likely need to consider reducing or delaying capital expenditures and M&A to focus resources on more critical activities. For instance, Uber recently decided to halt construction projects in Dallas and Chicago to prioritize projects that serve drivers and customers while everyone works remotely.
Stock buyback programs and dividends: Companies may need to pause stock buyback programs and cut or suspend dividends to preserve liquidity. As we’ve seen, continuing these programs after cutting payroll in any way can result in damaging blowback.
Some expenses cannot be cut — mortgages, insurance payments, utilities — but in most cases, the concept of “everything is negotiable” applies.
Still, while you may be able to postpone payments to conserve cash in the short term, think long term before making a move. For instance, one way to preserve working capital is to take longer to pay your suppliers, but that approach comes with risks. You could damage relationships and deprive supply chain partners of the cash they need to effectively maintain their own operations. That’s a short-term patch that could come back to bite you later, when business picks up. Instead, work with suppliers to find an arrangement that both parties can live with.
When considering cost cutting and delays, Stephens reiterates the need for caution.
“The cash flows you have the most control over are your operational cash flows,” he says. “Delay or eliminate every expense you can, but think long-term. Don’t damage your relationships with vendors or the trust of your employees that you’ll need when good economic times return.”
Tax payments: Strategic tax planning can help companies conserve cash in the near term.Deloitte recommends examining all options, including repatriating cash from non-U.S. jurisdictions, tax planning with respect to analyzing and filing refund claims and accelerating deductions or deferring revenue.
Additionally, the passage of the CARES Act provides several useful tax provisions for companies looking to maintain liquidity.
The employee tax credit within the CARES Act is meant to encourage eligible employers financially impacted by the coronavirus to keep employees on the payroll by providing cash flow relief. A qualified employer can use the credit to cover the federal income tax, the employee’s share of Social Security and Medicare taxes and the employer’s share of Social Security and Medicare taxes for all eligible employees. This refundable credit can be used by eligible employers to cover 50% of up to $10,000 in wages for each employee, for a maximum credit of $5,000 per employee.
Another provision within the CARES Act allows employers to delay payment of their portion of 2020 Social Security payroll taxes. Businesses that take advantage have until Dec. 31, 2021 to pay at least 50% of what is due for 2020, and until Dec. 31, 2022 to pay the remaining amount. Businesses do not have to demonstrate they’ve been impacted by coronavirus to use this deferral option.
Numerous other requirements have been loosened in the government’s relief plan — though applicability may be less broad. For instance, one provision removes the cap on excess business losses. Andrew Finkle, a partner at accounting firm Marcum, said that deduction used to be limited to $500,000 a year, similar to the $3,000 limit on personal investment losses from previous years. Now, any amount of past business loss can be applied this year, and the loss could effectively take a company’s tax bill down to zero.
Another provision changes how net operating losses (NOLs) are counted. Companies generating NOLs after Dec. 31, 2017 and on or before Dec. 31, 2020 can carry back such NOLs for up to five taxable years. This provision has an additional benefit of offsetting a greater amount of tax liability in those prior years. Simply put, companies now have the option of carrying the NOL back across the past five years to get a refund against taxes already paid, since they no longer owe as much.
Stephens cautions that companies need to talk to their tax experts to get a full understanding of the implications of these opportunities.
“Take advantage of the tax credits and payroll tax delays offered by the federal government,” says Stephens. “But, you can’t take some of these if you [received a loan from the Paycheck Protection Program], so do the analysis with your CPA to see which option is better for you.”
Receivables and payables: Companies should increase their focus on the cash-to-cash conversion cycle to ensure accessible capital. Ensure the company’s DSO stays low to help produce and preserve cash.
“Spend more time calling on your receivables,” says Stephens. “The collections department of a $2 billion credit union reported to me. The collections manager coached his staff to always show respect to borrowers. His practical definition for this was that the borrower would have a civil conversation with the collector if they ever ran into each other at a supermarket.”
Stephens recommends asking customers to commit to when they will make their payments.
“All future conversations are then just holding them to their word,” he said.
As a leader in a company that manages clients’ account receivables and payables, Polakoff re-emphasizes the idea of balance between collecting money owed and maintaining consumer relationships. Current times call for as much compassion for business partners as is financially possible.
“It’s really reaching out to both the suppliers and to the customers of the clients, having those conversations and creating understanding,” says Polakoff. “I think everybody understands the situation that we’re all in and are all trying to figure out how to balance it, where it still works for both sides. And that’s not an easy thing to do, but having that constant communication and transparency helps.”
|Tips for Managing Receivables and Payables|
|Offer a discounted payment in return for quicker payments||Check contracts to be sure that your company isn’t paying suppliers early|
|Engage with consumers to help prevent late payments, disputes or defaults||Map your business-critical suppliers to determine priority of payment|
|Send timely, thorough invoices and proactive reminders||Check for discounting opportunities with suppliers|
|Ensure there are no barriers to payment, such as invoice errors or delayed billing||Communicate to understand which suppliers may be at risk and which suppliers can potentially extend terms|
|Prioritize customers with large balances in the cash collections process||Ensure systems and processes are efficient to avoid delays and errors|
|Make sure your payment system is functional and convenient. Online with multiple payment options works best||Make sure that payment is performed through the agreed payment method|
|Define weekly cash collection targets||When possible, calculate payment terms from invoice receipt date rather than from invoice date|
Inventory management: When it comes to preserving liquidity, inventory management is a multi-faceted process. First, companies will need to update safety stock parameters and ensure that there is sufficient stock to buffer against a potential supply chain disruption. However, from a cash flow perspective, decreases in demand beckons the need to adjust both current and incoming inventory.
Inventory is an asset — but not a liquid one. Still, many organizations can take measures to convert it, even when demand is down. Businesses that act as suppliers may want to explore the option of consignment stock, which places inventory in the possession of retailers but does not charge them until the items are resold or consumed. While it does not provide immediate or guaranteed cash flow, this model can incentivize cash-strapped, hesitant retailers to stock products that might otherwise just sit and incur carrying costs.
In the case of outdated or slow-moving inventory, it may be necessary to pursue other options to contribute to liquidity. These could include:
- Discounting: Businesses can incite sales and convert inventory to cash by offering appealing discounts.
- Bundling: Ever heard of fukubukuro? The Japanese New Year custom started with department stores wanting to get rid of old stock. So, stores began selling mystery bags filled with random goods at a sizable discount. Now, it has become an annual tradition and nationwide craze. That may be an extreme example, but it illustrates the known benefits of bundling. This age-old retail tactic can increase revenue, raise average order value and shift slow-moving stock — efficiently converting inventory to cash.
- Auctions: An online auction can be a good option, particularly now, when people are spending a lot of time in front of screens. The use of auctions can increase competition, scope, transparency and reach for companies looking to monetize their resources.
- Donations: Dead or perishable stock may still have value to a charity. For instance, when Vail Resorts closed for the season, it donated more than 50,000 pounds of excess food to local food banks, schools and other nonprofit community organizations. The benefits are trifold: You generate goodwill by supporting the community, you avoid inventory carrying costs and you qualify for a tax break. Even better: The CARES Act increases the limitation on deductions for contributions of certain food inventory from 15% to 25% of the taxpayer’s aggregate business income.
When it comes to still operational inventory, companies should take measures to streamline costs and create an efficient inventory process that supports liquidity efforts. Improvements in end-to-end supply chain inventory visibility, demand planning, safety stock policies, production planning and scheduling, lead-time compression, network-wide available-to-promise and stock keeping unit (SKU) rationalization are the most likely measures to provide sustainable savings, according to Deloitte.
Team Monitoring and Metrics
In crises, tracking the metrics that matter is a much more granular and intensive process. Analyses and projections should be measured in days, not weeks or months.
While CFOs must maintain an unwavering focus on cash, not P&L, there are additional important KPIs, which may be different now than just a few months ago. Many companies are finding that the cash conversion cycle (CCC), days sales outstanding (DSO), days payable outstanding (DPO) and days inventory outstanding (DIO) have become their key metrics to track.
For these reasons, it may make sense to designate a centralized team for short-term cash metrics monitoring. Cash release decisions should be tightly controlled by either the CFO or treasurer. Some companies may even go a step farther and designate a “cash committee” to handle daily reporting and forecasting. This task force will carefully monitor key cash metrics across functions to ensure that determined cash position and projections remain accurate.
Megan O’Brien is Brainyard’s business & finance editor, covering the latest trends in strategy for CFOs. She has written extensively on executive topics as a former content creator for Deloitte’s C-suite programs. Reach Megan here.