In financially healthy companies, cash management is a complex activity undertaken in an effort to maximize overnight rates or minimize deposit float. In larger international companies, cash management may evolve into more sophisticated hedging activities focused on matching the currencies of assets or receipts and liabilities. A financially troubled company facing a liquidity crisis and borrowing constraints must take a totally different view of cash management and treasury activities in order to first survive and ultimately to complete a successful turnaround.

During a crisis, it is fundamental for financial managers to turn to receipts/ disbursement-based cash models. Cash models do not lie. If properly constructed and managed, they are brutally honest. They have a place in all aspects of the turnaround process, including the crisis phase, immediate action phase, stabilization phase, and emergence or liquidation phase. In a troubled company, a cash model is not only a tool to enable better communication with a company's bankers, it is an operating tool as well, enabling a company to take appropriate action sooner. And in today's economy, accuracy and timing are everything.

"Guerilla" cash management must include an active receipts/disbursement modeling process, allowing the company to better manage daily operations and get a clear picture of which of its activities provide or use cash. In addition to managing cash to optimize investment and borrowing needs, cash management must be used as a real time tool to enable senior management to identify and make critical decisions regarding what do to about losing operations.

Traditional planning mechanisms will not identify opportunities for cost savings fast enough in a crisis. These processes reflect a top-down, GAAP-oriented process. They often take too long or allow too much accounting gimmickry to enable management to gain a clear, rapid understanding of the profitability of parts of the company. The need for accurate data fast is especially acute in a bankruptcy.

A Powerful Turnaround Tool

By analyzing how a cash flow model is built and looking at its use through major phases of a bankruptcy case, the power of a good cash model in increasing the utility of the cash-management activity can be appreciated.

First, why is a cash model needed? A cash model gives management a necessary and powerful tool to manage discrete payments, communicate effectively with creditors and bankers about cash needs, and focus on the true cash flow of discrete operations in "real time" rather than several months later.

---

[M]any managers are surprised at how useful a good cash model can be through every phase of a turnaround, right into continuing management of the healthy company.

---

The timing of the cash model is important. Some of the choices with respect to timing include 13-week rolling forecasts, models with weekly forecasts for a couple of months and monthly forecasts thereafter, and models with a combination of daily and weekly forecasts.

There is no one right answer with respect to the proper timing of a model. The answer is a function of the size of the company, and the level of implied accuracy. A daily model implies the ability both to manage the model and all the company's major receipts disbursements at that level. A daily model may be fine for a $10 million company, but is not appropriate or feasible for a $1 billion sales company. Weekly models seem to work well for even the largest companies. However, the accuracy of weekly models decreases over time; i.e., the first several weeks of a 13-week forecast are far more accurate than the last several weeks in terms of timing and certainty.

Below are some rules of thumb to apply when organizing cash models for a troubled company. There is no one size-fits-all methodology.

• Receipt/disbursement models should be tied to a balance sheet item at some point. A model should show a periodic cash or revolver balance. Using this balance-sheet item, it can be determined when models are in or out of sync. Referencing a balance-sheet item also limits the ability to blame variances on "timing."
• Receipt/disbursement models should strive to represent the cash balance on a book rather than a bank balance, eliminating float. This adjustment should be made when the model is built, and updated periodically.
• Models should strive to represent data at a level of accountability, whether that level is divisional, product line or debtor vs. non-debtor. When cash shortages loom, accountability must be tied to specific line management.
• Pre-petition and post-petition expenditures should be segregated. Such separation is especially important when the company is preparing for a bankruptcy filing or has already filed one.
• Asset sale and divestiture costs should be shown separately. This data point is important during a liquidation analysis.
• For a liquidating company or division, cash needs should be identified by category. There is a separate receipts/ disbursement recovery analysis that takes into account all asset disposition benefits and wind-down costs.
• Models should demonstrate the differences in cash flows between debtors and non-debtors. Generally a problem only for larger companies, the financial model should be built with the appropriate intercompany loan and trade payable relationships to demonstrate the flow of funds among debtors and non-debtors. In a large multinational company, the DIP lender, creditor committee or non-debtor lending institution may limit flows of funds among such entities.
• Special attention should be paid to critical vendors, employee costs and benefits, trust taxes and professional fees.
• Actual cash expenditures should be recorded, and exceptions should be noted, with immediate action taken. These expenditures should be recorded and formatted in a manner similar to the model. Variances should be noted and investigated to determine if they are the result of timing or a change in the level of the receipt or disbursement.
• Finally, the structure of the model should suit the client's type of business. It should have the appropriate level of detail (i.e., $ thousands or $ millions) and time intervals (days, weeks, months). Appropriateness also goes to how the model is constructed. The following examples demonstrate how the structure of models for a manufacturer and a project-based company vary dramatically.

In an international project-based company, the model "rolled up" cash forecasts from operating units around the world that were based on receipts/disbursements forecasts for key projects. Since projects drove cash flows and the company had limited manufacturing operations, it was more important to roll-up the cash impact with respect to the timing of receipts and disbursements of major projects (using Pareto's law—the classic 80/20 rule) than to develop sophisticated modeling relationships regarding receipts and disbursements. Actual results were fed in from the operating units and compared to the forecasts.

In an automotive-parts manufacturer, the cash model derived receipts and disbursement assumptions from modified business plan models. From these models, variable cost relationships were derived from revenues, and timing differences could be estimated. Different assumptions were used for different products, and assumptions were layered in for fixed and large one-time costs separately. Actuals were fed into the model via the payables department and compared to the forecasts.

An Effective Tool Throughout the Turnaround

Obviously a cash model is critical at the beginning of a turnaround effort, when cash is low and every dollar must be accounted for. However, many managers are surprised at how useful a good cash model can be through every phase of a turnaround, right into continuing management of the healthy company. Here are some of the advantages to continuing to use the cash model as a management tool.

Cash Crisis

In this phase, the company may be approaching a bankruptcy filing or actively managing its cash while seeking an alternative lender or suitor. Having a model that shows a given spending plan's effect on cash is critical, as it enables management to shift and prioritize cash expenditures to maintain a positive cash position.

Management is also able to see large receipts on the forecast, and place special focus on operating and sales personnel to collect those receipts. The company can also use the model to make critical determinations about what expenditures implied by the plan are and are not realistic and prioritize among them.

Post-filing/Immediate-action Phase

For a company that has just filed for bankruptcy, an accurate and timely planning or financial reporting system may not exist. Thus, cash receipts and disbursements may be the only way to understand the business in real time. The cash model can also be used to track asset sales and their divestiture costs, as well as liquidation costs.

The model should be built with an eye toward accountability for cash receipts and disbursements. Accountability can be at any appropriate operating level, and will surely vary depending on the size of the company and the industry. No matter the industry, if the model is built well, it will very quickly expose which parts of the company are generating and which are using cash. While often the Treasury function will not directly be determining which operations are immediately closed, this information can be critical to senior management in deciphering different signals from the field and operations management.

In addition to being an excellent operating tool, the cash model is also an excellent communication device that can be used with creditors and bankers. It is difficult to acquire debtor-in-possession (DIP) financing if the banks and creditors do not feel that the debtor has a grip on its cash flows and an ability to project cash needs. In any case, the cash model should be built and consulted prior to setting covenants with DIP lenders.

Stabilization

In the stabilization phase, activity shifts from short-term tactics to assembling a long-term business plan and, if the company is in bankruptcy, preparing and filing a reorganization plan. Here, the cash model is a valuable tool for validating the results of the business plan. The model becomes a "leading indicator." That is, a business plan is generally built and compared to financial results that may not be available for several weeks after month's end. However, a properly built cash receipts/disbursements model can often show ending cash balances the same day. At this stage, while the company may no longer be desperate for cash, the model allows managers to see immediately where they stand vis-à-vis their cash flow plan and why.

Liquidation

Even successful turnarounds often include liquidation of parts of the business as an element of the turnaround. Besides being a wind-down budget tool, when coupled with an estimate of recovery for a creditor class, a good cash model can be a recovery analysis, a valuable part of a chapter 11 reorganization plan for a liquidating debtor.

For a liquidating company, the model may make less use of formula-based submodels to derive receipts and disbursements. Instead, it becomes the record of all major current and future receipts and disbursements. Building such a model is based less on developing sophisticated formulas and relationships, and more on extensive interviews and meetings. Nonetheless, if people are told that money will not be spent if not included in the model, it is easy to quickly gain an understanding of major disbursements.

Turnaround/Emergence

At this phase, the company has turned its operations around, and if in bankruptcy, is embarking on the implementation of a reorganization plan. Ideally, the company has acquired exit financing and is cash-flow positive from an operations standpoint.

The rolling cash forecast can still provide value. The activity of assembling required data at the appropriate interval ensures that there is constant attention paid to the impact of actions on cash flows. An actively managed cash model leads, in the long run, to a more efficiently run company.

By this phase, hopefully the treasury and business-planning personnel have figured out how to link a largely bottoms-up cash model with a top-down business plan. Each month, actual ending cash balances or debt balances can be compared to the plan to determine how well the company is doing vs. the plan and why. This information is often instantly available from the cash forecasting process, but will take longer from a business planning process. The advantage of the cash model is that any required action can be taken sooner.

Cash Forecasts—A Tool Providing Rapid Feedback Throughout the Turnaround Process

In a company facing liquidity challenges, quick decisions need to be made about where to apply scarce cash resources and how to get more cash out of the business. Detailed receipts/disbursements forecasts that look forward 12 or more weeks give management a true sense of where and how operations are generating or using cash flows. While such models can be highly customized for the type of business, they should always strive to break cash flows out in a meaningful manner that allows for accountability and identification of key expenditure categories.

Once the cash model is built, it is useful throughout the turnaround process. The model evolves from being a device to stretch cash in the early phase of the turnaround, to being an early indicator of cash flow success. Throughout the turnaround process, the model is a useful communication device that can be used with constituencies throughout the case.

Footnotes

¹ John Dischner is an associate in the Chicago office of AlixPartners LLC. Return to article