It’s true. Some CFOs, particularly in the large-cap sector and/or in industries with extremely high margins, actually have the problem of too much cash, and have to decide how best to put that cash to work. Most lower-middle market CFOs dream of having that “problem”. For them, cash on hand is ALWAYS king. Even though earning a sufficient return on surplus cash is a genuine concern for some companies, the truth is most companies in the lower-middle market will not experience this dilemma. At least, they won’t experience it in any long-term, strategy-defining way.
In fact, the focused preservation of cash will be absolutely critical to the survival of many lower- middle market companies at some point. Unfortunately, that “point” has come for many with the ongoing COVID-19 disruption. Cash in the bank allows you to sleep at night – period. Knowing you’ve got your next payroll covered with cash left over to pay your vendors (which should always be the order of things) is a huge comfort. Don't get me wrong, choosing which vendors to pay, and how much to pay them, can be a gut-wrenching process. But, not knowing whether you’ll be able to cover payroll … that’s ulcer-inducing stress. You want to limit that!
For CEO’s who own the F&A function themselves, and for those CFO’s or Controllers who could use the reminder, as you enter a period where cash preservation becomes critical here are some key principles to keep in mind:
1. Track your cash every single day. Ensure your key accounting person or bookkeeper knows what the reconciled balance is (i.e. how much you’re floating in outstanding checks and which deposits haven’t hit the bank yet). Most well-managed lower-middle market companies do this as a matter of habit.
2. Utilize an “exploded”, weekly cash projection, with outflows by vendor, to supplement your 13-week cash-flow forecast, which likely forecasts payments at a more general level. An exploded weekly forecast allows one to manage that detail appropriately and focus on the immediate, near-term cash issues. Again, this is something most companies do even when times are good, but is critical in the lean times.
3. If you have a separate payroll account, as a rule, fund it first. This can be a simple method for remaining disciplined about the order of cash outflows. Regardless, limit your cash outflows for the week to “keeping the lights on” and nothing else until that next payroll is covered. Stay disciplined, even when the vendor calls and emails are nonstop.
4. After you’ve covered payroll for that period, spread the love amongst your vendors. What I mean by that is don’t get caught in the trap of paying one large, lump sum to one or two vendors (who also may be screaming the loudest) because it will magically wipe out a large balance you owe. Sometimes that’s a necessary move when ultimatums have been laid down and relationships are on the line. However, normally you’ll want to send as many meaningful payments to as many vendors as you can, weighted by 1) critical near-term operational needs, 2) the importance of the relationship, and 3) outstanding balance. Cash coming in their door always signals to your vendors that you at least have the right intentions. That said, if the amount you’re paying relative to the balance is extremely small don’t bother – you may just be “poking the bear” and asking for more complaints. You’re probably better served making a larger payment to another vendor.
5. Communicate with your vendors and your employees.
a. Your vendors – call them, email them, etc. Don’t ignore them. When times are tough and you’re cherry-picking vendor payments, this will go against almost every natural feeling or inclination you’ll have because you’re human, and you know they’ll be disappointed that you can’t pay them in full. However, communication is vital. Let them know you value the relationship, you respect the terms that were agreed to and you want to honor those terms, and that you’ll do everything you can to pay them in full. Let them know this will be short-term, and then things will get back to normal. If appropriate, particularly if it’s a key relationship (like your largest inventory supplier), create a payment plan that is tangible to them and to which you both agree. You’ll find that more often than not, vendors will be agreeable. You may even be able to get them to waive interest or late-payment penalties.
b. Your employees – you need to let your operations and accounts payable (possibly even your receptionists) team know the situation and that you’re doing your best to pay everyone because it is they who will hear from vendors first. As a leader, it is your job to instill confidence and a sense of calm, and to ensure your messaging to vendors is coherent and consistent across your organization. Develop a system for who will respond to vendors and when, and ensure everyone is on the same page. And, don’t shirk the responsibility of fielding some of that communication yourself – hearing from you may be more important to your vendors than anything. Though not as effective as a personal message, you may consider sending blanket messages to all vendors, in “a letter from the CEO” format, multiple times throughout the cash crunch period.
Now, a word about overall liquidity and bank lines of credit. If you have a bank line of credit, often referred to as a “revolver”, you have flexibility that many don’t. It was likely secured by your personal guarantee, or, if you’ve been recapitalized by a private equity firm, there likely is no personal guarantee and the line was negotiated as part of the total credit facility. Either way, it is a source of cash, or liquidity, to you. Most 13-week cash flow forecasts resolve to the overall liquidity of the company by including draws and repayments on the line of credit. There is a lot that can be said about lines of credit, particularly by the bankers who grant them and the private equity professionals who negotiate them with every new investment, but let me add a few thoughts:
1. Be careful in borrowing on the line of credit – don’t treat it lightly. Often it is necessary and you have no choice to fund working capital needs; however, understand that in borrowing on the line you’ll obviously have to repay it at some future point and you’ve just decreased your future borrowing ability (when the need may be even more critical). In addition, you’ll need to monitor where you stand with your debt covenants, per the credit facility agreement. Those covenants will limit the total amount of outstanding debt you can have at any point in time relative to your earnings before taxes, depreciation, and amortization (EBITDA), and will ensure you have enough EBITDA to cover principle and interest payments. In other words, even though the bank has made the money available to you to borrow, borrowing may jeopardize your overall credit facility and put you sideways with the bank.
Lines of credit, as part of the total credit facility, are secured by all the assets of the company. However, you are only eligible to draw on them to the extent you 1) stay in covenant (per above), and 2) have the “borrowing base” to support the line. Specifically, the borrowing base includes your accounts receivable and inventory. The bank will have given you the specific calculations for determining the borrowing base amount and how much you can borrow on the line relative to it. Remember that as sales drop, so will A/R, and that borrowing base will diminish – meaning you have to be vigilant about your line of credit balance and ensuring you haven’t exceeded the borrowing base.
2. Conversely … ideally, you’ll borrow on the line of credit from time to time, and pay it back relatively quickly. The bank may even require a “clearing” of the line balance to zero on an annual basis (hence the term, “revolver”) as a specific covenant. It’s somewhat analogous to your personal credit and obtaining a new loan and then paying it off, which boosts your personal credit score. The bank generally views activity on the line of credit positively (lending is their business after all). Drawing on the line regularly, and executing on a clear pay-back strategy/timeline, can be a wise use of funds and build credibility with your banker and, more importantly, with the bank’s credit committee. And, be aware that you will pay bank fees on the unused portion of your line of credit.
Remember, “cash is king” as they say – nothing is more important to your business than the cash coming in the door from your customers. When that cash inflow slows, for whatever reason, you need an immediate and effective response plan. And cash crunches will never be pleasant; however, most lower-middle market companies will experience them at some point in their evolution. By following principles of good cash management and responsible use of borrowing, you can successfully manage through those time periods and come out on the other side ready for what’s next.