Liquidity – Further Thoughts on a Lesson From Past Crises

fdu’s guest blogger, David Tilston is a Chartered Accountant, a Fellow of The Association of Corporate Treasurers and a member of The Institute for Turnaround. He has held CFO roles in both listed PLC and PE-backed companies and has significant experience of managing turnaround situations.

I recently wrote about one lesson on liquidity I have learnt from past crises and expand on some practical aspects in this article:

The lesson

Get a 13 week rolling cashflow forecast started as soon as possible, ideally this week, and update it weekly.

The assumptions driving liquidity

Key assumptions will be required around both the timing and amount of cash receipts from debtors and cash payments to creditors. Many businesses may find that a limited number of customers account for a high proportion of cash receipts. If so the best approach will be:

  • to forecast cash receipts at the customer level for the major customers, and
  • to make a more general assumption (ie average days to receipt) for the balance.

These assumptions will be dynamic given the current economic environment and may change on a weekly basis.

Integrity of forecasts

It is important to periodically ensure the cash forecasts get trued up with the primary statements such as the monthly management accounts P&L and balance sheet to ensure no material inconsistencies or unreconciled differences are arising which might invalidate the forecasts.

As a minimum the opening cash balance in the relevant forecast needs to be reconciled very closely back to the cash balance shown in the last available balance sheet (even if this cannot be done immediately).

It is essential that all intra-group payments between subsidiaries net out to zero on a week by week basis to ensure there is a clean view of the group position on consolidation.

The review process

Some of the obvious questions to ask are:

  • When reconciling changes from week to week, are the differences temporary or permanent in nature? If a customer has simply delayed a payment from one week to the next then the business is only facing a short term phasing impact – but if the customer has become insolvent then that would reflect a permanent difference in the projected cashflows which would consequently deteriorate overall.
  • Do the weekly cash receipts from debtors broadly reconcile to the movement on the debtors ledger (ie opening debtors plus new invoices issued less cash receipts equal closing debtors)? If not then what are the major reconciling items and do they imply an impact of cashflow forecast? How are actual cash receipts moving on a week-to-week basis and what is the trend?
  • Are there any critical concentrations of cashflows in any days during the month? For example, if all customers normally pay on 27th of the month and all salaries and suppliers are paid on 28th of the month there could be a significant risk around having the cash resources to make payments if some material customers temporarily defer payments.
  • Is the cash easily available in full for deployment elsewhere in the Group at short notice or not? If some of it is located in overseas bank accounts that may not be the case, and this may reduce your headroom.

When reconciling changes from week-to-week, are the differences temporary or permanent in nature?

Active management of working capital to improve liquidity

The working capital balances do require active management. This is likely to involve dialogue with the major customers (possibly also involving CEOs and CFOs) to confirm the timings and amounts of cash receipts expected.

With regard to managing the payments cycle, there may be critical suppliers who are both financially challenged and difficult to replace. It may be prudent to prioritise payments to these suppliers in order to support their solvency and keep them in business.

There will be delicate judgements around inventory management as the organisation seeks to balance the conflicting challenges of:

  • minimising stock to conserve cash resources
  • maintaining sufficient stock levels to meet customer service timeframes
  • ensuring sufficient raw materials are available with regard to the strength of the supplier base and risks of supply chain disruption.

Communication and understanding

With remote working a factor for many teams, clear communication and review of the cashflow forecast will be both challenging and essential. It is critically important that the Finance function avoids jargon and keeps messages simple and easy to understand with other functions.

On several occasions I have shared the cashflow forecast with the broader management team, in one case showing that we were going to run out of cash in eight weeks. Their response was one of relief as at least they understood the context for the actions the directors were asking them to take. It certainly incentivised them to collect outstanding amounts due!

“It is critically important that the Finance function avoids jargon and keeps messages simple.”

Risks, scenarios and overlays

Time and resource permitting some high level scenarios around major assumptions (say on a high, medium, low case) might be helpful to understand the materiality of impact if they are wrong.

The cashflow forecast can then be used as a basis for deciding the actions to be taken to improve from the base forecast, the size of the cash impact and when these will be delivered. The thrust will be to maintain the maximum amount of cash resources, and also to ease pressure on any tight points by rephasing cashflows where possible.

Directors do however need to be sensitive to a wide variety of stakeholders and that their actions to conserve cash and ensure survival are not seen as being egregious and damaging to longer term aspirations.

Finally – when the rebound comes

Previous downturns have shown that many businesses who have survived a severe economic downturn actually go out of business as trading recovers. The driver for their collapse is the difficulty in financing increased working capital balances as they have to pay suppliers for increasing amounts of raw materials whilst building inventory and seeing the debtors ledger increase.

Consequently the 13 week rolling cashflow forecast is equally important for when activity recovers as when it declines.

Again – the lesson

Whilst the above article puts more detail around the considerations, the key message remains:

Get a 13 week rolling cashflow forecast started as soon as possible, ideally this week, and update it weekly.