Forecasting Cash Flow to Navigate Business Downturns

Posted on May 5, 2020

By Scott Zickefoose, CPA, CM&AA, Transaction Advisory and Tax Senior Manager

Evaluate Near Term Liquidity with a 13-Week Cash Flow Model

A mantra often repeated in business is, “cash is king”.  Cash, or the access to cash, is the lifeblood of the business.

For businesses in distress, or anticipating downturns, it is important to begin forecasting cash flow for the near future. Doing so allows managers of the business to be judicious and intentional in how they manage the cash they have, and anticipate to receive, as well as identify shortfalls in advance.

A standard tool used by seasoned managers and consultants to evaluate the near term liquidity needs of the business is a 13-week cash flow model.  A 13-week cash flow model is a tool that is used to guide management decision making, helping to stay focused on capital preservation while continuing to operate the business. Building a 13-week cash flow model takes considerable thought and effort. While a 13-week cash flow model can be extremely beneficial to all companies, including those flush with cash, the rest of this article is focused on companies with stressed liquidity positions and those experiencing contractions in their business.

A business owner/manager with stressed liquidity positions should think about the following items:

Focus on Cash

Many businesses report on the accrual basis.  Many business owners and managers are accustomed to focusing on generating sales and driving top line growth. In this exercise, the owners/managers have to shift their focus from accrual basis and think about cash inflows and outflows. Understanding the business’s cash conversion cycle, and the ways in which management can help modify this cash conversion cycle, will be key in performing a 13-week cash flow and preserving cash as we navigate any business downturn.

Circumstances are Different

Models are built on assumptions and the 13-week cash flow is no different. It is often said that history is the best predictor of the future and as such, the default assumptions in models are often based on the historical results of the business. It is easy to oversimplify the 13-week cash flow modeling by saying things like, “our customers have historically paid us within 30 days of invoice”.  While history is helpful, it is important to question whether the current circumstances will change any of the behaviors of the company’s clients. Are they also in a distressed environment in which they will attempt to stretch the age/terms of the invoices? Will the company’s vendors be less apt to extend credit terms based on their current circumstances?  Incorporating this new reality into the cash flow modeling, by changing assumptions to reflect your best estimate of the current circumstances, will be necessary to improve the accuracy of the model.

Involve the Team

To the extent possible, it is important to involve key members of the company’s management. Representation and input from a variety of business functions will be key to improving the effectiveness of the 13-week cash flow modeling. A sales leader will have insight into sales pipeline, collection expectations, and customer insights that will be helpful in understanding the anticipated cash collections over the next 13 weeks. Procurement and inventory managers will be able to offer insights into necessary expenditures and ways of modifying inventory and procurement practices to preserve cash while continuing to operate the business. Human Resource representation will allow for insights into ways of modifying salary and benefit expenditures, depending on the company’s objectives. The input of the various function leaders will allow for a more robust, and hopefully more effective, 13-week cash flow model.

Prioritize

Change requires resources. As such, a business likely cannot make all desired changes at once. In the process of developing a 13-week cash flow model, take the time to think through which changes to the business will have the biggest impact and which are most achievable. Prioritize the changes that have a reasonable certainty of success and have the biggest impact on the business’s liquidity in the near term.

Debt Service

A 13-week cash flow should first be prepared without regard to debt service. A distressed business needs to understand the anticipated cash flow from operations prior to approaching lenders and other creditors about modifications to debt service. A business owner/manager can use the insights gleaned from a 13-week cash flow statement to understand what debt service, if any, is reasonable to make over the next 13 weeks. Approaching lenders with a well thought out model will establish credibility and allow for a more meaningful conversation about modification of debt service terms to provide short-term liquidity, such as interest and/or principal deferrals.

Prepare to be wrong

As discussed above, models are built off of assumptions. As such, keep in mind that you will not forecast with 100 percent success. It is important that the 13-week cash flow process is iterative rather than static.  At the end of each week, update the assumptions for the coming weeks.  What happened that was unexpected?  What could have been done better this week to generate or preserve cash?  It is important to separate expectation variances into two categories – those that are timing differences and those that are permanent differences.  Timing differences are things you expected to happen, just the timing is different. This can be the timing of a payment or expense happening sooner than you expected. Permanent differences are things you didn’t expect and will not reverse over time. This could look like an unexpected repair/cost or a customer bankruptcy resulting in fully reserved receivables.  Analyze these variances and take these lessons and insights to improve the model. Update the assumptions and continually evaluate them. This iterative process will allow the business owner/manager to improve the accuracy of the model and allow management to make more informed decisions.

The Keiter Advisors team has significant experience assisting companies understand the drivers of their cash conversion cycle and thinking through ways of strengthening the business’ cash conversion cycle, in a variety of circumstances. If you are considering preparing a 13-week cash flow statement and would like assistance, please reach out to any member of the Keiter Advisors team.

Scott Zickefoose

Email: szickefoose@keitercpa.com

Phone: 804.273-6253