How a Distressed Company Can Manage Cash and Stakeholders in a Liquidity Crisis

Considerations for Companies in a Cash Crisis

A liquidity crisis is a dire financial situation. A company lacks cash or cash-convertible assets. This can lead to defaults and bankruptcy. Managing money is vital. It preserves solvency and maximizes chances for a successful turnaround or restructuring.

Near-Death Liquidity Is Like a Melting Ice Cube

Insufficient liquidity shrinks the range of options for a financially distressed business. The metaphor of a melting ice cube is often used to illustrate this situation. Your cash is like an ice cube. Unless the ice cube is refrozen (i.e., replenished) over time, it will eventually melt (i.e., run out). When no additional credit is available, cash runs out, and the company cannot pay its employees or vendors. At this point, the business has failed, and recoverable value collapses. The ice cube has melted.

Business leaders without ‘near-death’ liquidity crisis experience may lack the skills to fix them. In these situations, outside assistance, such as from a restructuring advisor, is often required to develop and implement strategic alternatives. When corporate resources are too thin, management must urgently fix cash flow issues.

Situational Analysis and the Cash Flow Forecast

A situational analysis will provide a rapid, factual assessment of the current situation. This analysis must include a thorough review of the company’s cash position through a detailed cash-flow forecast that reflects all incoming and outgoing cash sources.

A restructuring expert’s review of the company’s options is based on a detailed 13-week cash-flow forecast. It is the best tool for managing cash issues in a crisis. The cash-flow forecast, in budget form, must disclose cash sources and uses. It must be based on clear, accurate assumptions. Earnings before interest, taxes, depreciation, and amortization (EBITDA), often used as a proxy for cash flow in non-crisis analyses, should not be used for the crisis cash-flow forecast. Including non-cash items in earnings can be misleading. So can excluding cash needs for capital expenditures and working capital. Working capital requirements — or operating debt — include accounts payable, accrued expenses, and other liabilities due within a year.

Management must find ways to speed up incoming cash. They must also conserve cash on hand while allocating cash outflows. With help from advisors focused on fixing cash issues, managers can lead their company through a liquidity crisis.

Throughout the process, cash remains king, and managing money is paramount. This applies to cash on hand, cash from operations, and one-time sources of money. It also applies to other sources of liquidity. All must be considered in establishing options, developing strategy, and preparing negotiating positions to support an informal out-of-court restructuring, a bankruptcy filing, or another alternative (e.g., self-liquidation, Article 9 sale under the Uniform Commercial Code, assignment for the benefit of creditors).

The company’s cash will limit its options and timeline for a turnaround plan. In almost every case, managers must simultaneously pursue multiple options on separate tracks.

Potential Issues in Managing Cash

Potential issues in managing cash include—but are not limited to—the following:

Borrowing Capacity/Excess Collateral Under Existing Borrowing Facilities

Usually, you can negotiate waivers of defaults with secured lenders during early-stage distress. However, a workout or rules may reduce the company’s borrowing. This could, in turn, precipitate a liquidity crisis.

If the lender sees its position is not secure and that operations are ’burning cash,’ it might prefer to foreclose or pursue bankruptcy. Both options would protect its collateral position and make it easier to monitor management.

Considerations include the

• Debtor-in-possessions (DIP) financing’s ability — either with the existing lender or a new lender — to provide additional borrowing availability
• Status of existing defaults and lender fatigue
• Rates and fees associated with DIP financing proposal(s)

Access to Trade Credit from Existing or Alternate Vendors

Good relations with trade creditors (i.e., where payments to vendors have not been stretched to the breaking point) might enable the company to establish a standstill on ‘old’ payables during the implementation of the turnaround or restructuring plan, which would conserve cash and allow time to put cash-flow initiatives in place. With enough money, it might be possible to negotiate a deal with creditors. It could allow for deeply discounted payments or extended terms on old payables.  Vendors could keep or gain a profitable customer relationship. If landlords negotiate, their maximum bankruptcy claim will affect the settlement terms.

Considerations include:

• Structure and number of vendors
• Current payment status on shipments made on open terms
• Length of relationships
• Collect-on-delivery (COD) requirements
• Lost suppliers
• Availability of alternate suppliers

Ability to Implement Profit Improvement and Cash Flow Initiatives

The cash flow forecasting process can provide:

• Key insights into the drivers of operating cash flow and margins. This allows for a detailed analysis of: days sales outstanding, inventory turnover, unit volume changes, and pricing/cost trends.
• Identification of opportunities to shorten the cash conversion cycle, accelerate cash flow, improve cash-flow margins on product and service offerings, and eliminate cash drains.
• Assess the capital expenditures and non-core investments. They affect cash flow.

Considerations include:

• Extent that the company depends upon a limited number of products, services, vendors, and customers
• Capital intensity of the business

Managing Stakeholders in a Liquidity Crisis

The turnaround team must be open about the cash issues facing the distressed company. They need to communicate effectively with other key stakeholders — senior debt, subordinated debt, trade creditors, employees, and equity — about cash issues and the momentum towards resolving them. A 13-week cash-flow forecast can build trust among stakeholders. This is vital for managing the company and protecting creditors as it goes from near insolvency to actual insolvency.

It’s difficult to reach an agreement on a turnaround strategy among stakeholders with diverse agendas and uncertainty — and possibly confusing information, including competing valuations. Management and turnaround teams can reduce strategy conflicts. They can do this by addressing cash issues, using the right tools to manage cash, and communicating the cash situation to all stakeholders. This will maximize the company’s value for all stakeholders.

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[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Current Trends in Leveraged Finance
2. Help, My Business is In Trouble!
3. Tricks and Traps in Leveraged Finance

This is an updated version of an article originally published in December 2018 and updated on May 14, 2021.]

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