Liquidity Turmoil

Liquidity Turmoil

CFO perspectives on improving your cash position
In light of our recent (hopefully temporary) economic downturn, I want to share perspectives on making the most of your available cash and thus improving the longevity of your enterprise (and jobs!).
I set out to discuss how hands on income statement and balance sheet management can become a source of short and medium term cash as an alternative to raising external capital or taking up new loans. Divided into two parts:
  1. Thoughts on Balance Sheet management
    a. Hidden value in assets
    b. Cash reserves
    c. Improving the fundamentals of working capital
  2. Income Statement management
    a. Reducing expenses -- short/medium term
    b. Government subsidies
With a balanced approach, business owners and managers can extract significant value from their enterprises -- hopefully enough to tackle the current Covid-19 fuelled economic downturn.

Balance Sheet Management

Hidden value in assets

All companies tend to have elements of hidden value which can range anywhere from tangible assets, overdue accounts receivables and/or various reserves (for instance for profit tax).
Taking out loans on some of your assets; these can include, but are not limited to:
  • sale & lease back on production equipment -- the machinery itself as collateral, however it would not surprise me if directors' guarantees are required in today's more restricted credit climate
  • mortgage on any commercial real estate
  • Arrangement of consignment stock from suppliers, essentially your suppliers would buy back any inventory you have in storage but without moving it, you pay for it when you use it. This would work more often if your suppliers are more cash rich than you
  • Consider discounting any finished goods to good customers

Cash reserves

Additionally, all companies tend to have cash reserves for enabling profit tax payments at the end of the operating period. With falling income, these reserves may not be needed in full and can likely be released to support the business in the short term.

Extracting cash from working capital

Working capital is constituted of inventory, receivables and payables. The formula for calculating working capital is thus:
Inventory + Receivables -- Payables = Working Capital.
Reducing working capital can be done either by reducing inventory or receivable or increasing payables -- or a combination thereof. Let's discuss these three individually.
  1. Factors driving inventory include number of items in inventory, distance to and flexibility of suppliers, throughput time in production, etc. Workstreams that can be created addressing a reduction in inventory include for instance:a. Investigate if your supplier(s) can hold a consignment stock in your warehouse, the items only become yours when you call on the inventory. This can be possible with longstanding suppliers and/or cash rich suppliersb. Reduce complexity in your inventory -- attempt to carry fewer versions. It is usually the case that 80% of sales is derived from articles constituting 20% of inventory. One can decide to increase the availability of high sales items and make some less sold items less available. This strategy can also be facilitated by increasing the prices of less common items thereby driving the volume to the higher volume goods. It is traditionally the case that the low volume items carry a proportionally higher cost which is rarely taken into consideration in pricing.
  2. Accounts receivables constitutes invoices sent but not yet paid. Receivables is the function of payment terms agreed in negotiation or simply written on invoices sent out. Examples of initiatives to reduce accounts receivables include:a. Reducing days payment outstanding (DPOs) on invoices sent to your customers. A common number of payment days is 30 -- but more and more companies reduce this to 15. For some customers this can be easily achieved whereas others will want something for it -- most commonly reduced pricesb. Introduce cash-on-delivery discounts (COD). Many customers are happy to pay almost instantly if they can get a couple of percent discount on the invoice amountc. The selling of invoices to credit institutions is called factoring. Depending on your credit history and the nature of the invoices the haircut on the invoice amount varies. The downside of factoring is that buyers of invoices would like a long term relationship (no one off business) and the credit institution will take over the customer relationship on the payments front which might damage future sales.
  3. Accounts payables is the sum of all outstanding supplier payments. They are a function of the payment terms laid out on incoming invoices. Much can be done on the payments side, including for example:a. Extending payment terms (DPOs) offered by suppliersb. On maturity, pay your invoices with a credit card. The most common number of interest free payment days on a credit card is over 30 days thereby doubling your accounts payables. Many suppliers however do not accept credit card payments, this is where Billhop will be able to help you. To read more, please visit Billhop.

Income Statement management

The best way to cure an income statement is to increase the income. However, today's sickness stems from a reduction in income which calls for another type of income statement adjustment. It is generally better to take difficult decisions sooner rather than later, especially for such companies that do not enjoy cash rich shareholders.

Reducing expenses -- short/medium term perspective

Generally speaking, all cost is more or less avoidable. However, one proposed method is to sit down with a complete itemised cost report for the last quarter. Simplified, each cost item is either variable cost or fixed cost. Variable cost goes up or down depending on sales whereas fixed costs are relatively constant in a bracket of sales (over a certain threshold you will need to build another factory, but until that time one will do).
Variable cost will oftentimes reduce with sales but could require a nudge in the right direction -- for instance travel ban, reducing involvement from consultants, removing overtime working hours. Cost will rarely reduce without initiative.
The truth is that you can only get so far in with variable cost and whilst you may be able to reduce fixed cost temporarily (salary reductions, rent exemptions etc.), fixed cost elements require a different type of initiative, letting staff go, reducing office space along with output capacity. Any reduction in fixed cost must go hand in hand with corporate strategy.

Government Subsidies

Keep a close look at subsidies offered by your Government at this difficult time. In many cases, Governments have gone all in ranging from tax exemptions, Government paying part of salaries to making cash available to SMEs. It is worthwhile accepting any help your Government can provide.
Ingemar Sjögren,
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