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Operating Like a Turnaround (Before You Have To) — Part 3

[Part Three in a three-part series discussing the benefits to healthy, profitable companies in taking a page from the turnaround management playbook.]

In our previous blogs, we discussed operational analysis and expansion planning as it pertains to unlocking capacity and growth. In this installation, we focus on the projection, timing and tracking of cash flows.

HOW CAN YOU HIT A TARGET IF YOU’RE AFRAID TO CREATE ONE?

The 13-week cash flow forecast is the industry standard for basic performance measurement in a turnaround situation. Every cash inflow and outflow is matched against projections, with variances (positive and negative) scrutinized for the underlying causes.  This tool provides an enhanced level of transparency into a company’s performance, which is at the same time crucial for management and demanded by creditors.

When applied to a healthy company, the 13-week cash flow forecast allows management enhanced clarity and transparency at a granular level. This can lead to quicker, more informed decision-making in both the core operations and expansion initiatives. This level of clarity, starting at the C-Suite, can be pushed down into the entire organization, unifying all manager-level employees with a common language.

The 13-week cash flow forecast can roll forward on a weekly or monthly basis, creating benchmarks for monthly tactical reviews and quarterly strategic reviews.  Essentially, it becomes the core tool to benchmark a company and its management against an agreed strategic operating plan, with factual data forcing accountability for performance.

IMPLEMENTATION & TRACKING

Tracking actual performance to projections is a powerful indicator for your business. It provides a crucial level of awareness, giving you the opportunity to detect problems, recognize strengths and evaluate initiatives. Without some form of tracking vs projections, you’re really on a road trip without a map: no destination and no evaluation of progress towards the same.

Cash inflow projections are based on detailed knowledge of your operational capacity, sales cycle and customer pipeline. They should reflect what you can realistically expect your system to generate: known customer demand, order backlog, production capacity, inventory, length of sales cycle – all these factors must be carefully considered in creating your revenue projections.

Remember that you’re not just projecting revenue – you’re anticipating when cash will actually hit your bank account and be available for use. Cash inflows that fall short of projections provide notice as to a host of potential issues, including operational/production, sales efficacy, customer demand and customer solvency (collections).

Alternatively, cash inflow actuals deviating substantially to the upside alert you issues such as market demand and “sweating” assets, potentially indicating the need for expansion and investment. In either case, deviations from projections can be given immediate attention rather than delaying or ignoring issues due to ignorance or untimely knowledge of them.

Cash outflows are created based on when you anticipate actual payment of expenses. Factors to be considered are escalations (think rent and inflation), anticipated equipment/asset purchases and hiring initiatives. If you pay expenses with a credit card, those payments should be considered cash outflows – money that has essentially left your bank account and is no longer available for use. Actual outflows that exceed projections could be an indication of a lack of grounded operating knowledge, inefficiencies, supply chain issues or a lack of proper controls.

TIMING & ALLOCATION

It’s also important to get the timing of cash flows right. Every business essentially matches cash inflows to outflows, with the goal of being able to meet obligations as they come due and to calculations of IRR. Cash that comes in later than expected can cause a lot of heartburn when outflow obligations materialize, leading to ad hoc cash management that diverts cash from other pre-planned activities. Cash flow mismatch also communicates to investors that you don’t have a solid grip on your cash management, eroding confidence in management and the business in general, potentially resulting in valuation discounts.

Projecting future cash balances allows you to plan for capital allocation and anticipate financing needs. Accurate cash flow forecasting shows lenders/investors/buyers AND current shareholders (including yourself) that your company is tightly run and it instills faith in your management acumen.

Perhaps most critically, a well-executed cash flow forecast creates a level of fact-based understanding of your company’s operations that can be used as benchmarks for accountability for you and all those in executive or management functions.

The bottom line is that as a business owner, you must have deep knowledge of how both cash and work flow through your business. Lack of visibility on either of these key aspects leaves you vulnerable to very unpleasant, yet very avoidable surprises.

Mark Taffet is CEO and Wolfgang Tsoutsouris a Managing Director at MAST Advisors, Inc., an M&A and strategic advisory firm focused on maximizing value for middle market companies.

Securities Offered Through SPP Capital Partners, LLC. 550 Fifth Avenue, 12th Floor, New York, NY 10036 Member FINRA/SIPC

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Accessing the Private Capital Markets: Cash Flow vs. Asset-Based Borrowing

Many CEOs believe the amount of reasonably priced senior capital their company can obtain is limited by the hard assets that can be pledged as collateral: inventory, receivables, machinery, equipment, etc.

That is simply no longer true.

Over the last two decades, the success and profitability of US businesses have become less dependent on owning hard assets.

Highly skilled people, technology, customer experience, provision of services, and other forces are the predominant factors in a company’s health. Even for asset heavy businesses, the difference between success and failure is usually not their hard assets, but having the people, strategies, processes, systems, and technologies to beat the competition.

Private Capital Market participants have developed a deep and flexible toolkit to provide capital that fuels this evolution in the US economy.

Commercial banks, especially in the lower middle market, tend to be more asset focused. Their basis for lending is having sufficient collateral so their loans will be paid off if the borrower has to be liquidated.

Non-bank lenders and some commercial banks are increasingly “enterprise” vs. asset-based in their investment analyses. For these lenders, EBITDA, “Adjusted EBITDA,” cash-flow available for debt service, and getting comfortable with the quality and consistency of a company’s earnings have replaced the liquidation value of hard assets as the basis for providing capital to clients.

Asset-based lending is still the least expensive, and for smaller companies perhaps the only form of senior capital available. Once a company passes $3 million in EBITDA, private capital market participants want to talk.

Key differences between asset-based and cash flow borrowing include:

  • Cost: cash flow borrowing can have interest rates 2%-4% higher than asset-backed loans
  • Capital Available: commercial banks and asset-backed lenders are usually limited to fixed percentages of available collateral, and top out at 3x EBITDA. Cash flow lenders can go to 4.5x EBITDA on senior debt. This additional capital availability can make a significant difference for companies that have good use for funds.
  • Amortization: Banks will require a minimum of 10% fixed annual amortization, and often more, depending on the terms of a loan. Cash flow lenders can create amortization schedules that are flexible and may be as low as 1%-5% annually. This allows more of your cash flow to be re-invested or used for dividends.

The flexibility available to companies seeking funds from the private capital markets is not a “one size fits all” proposition.

For many companies, a blend of asset-based and cash flow borrowing might create an optimal outcome. For others, very low cost asset-based borrowing might be the right way to go.

If you are the CEO of a healthy company where success and profitability are not based on having more hard assets, and where growth investments (whether for organic growth or external acquisitions), buying out partners or “taking some chips off the table” are smart things to do, cash flow based borrowing may provide more capital at a lower cost than you had thought possible.

This article addresses only the narrow topic of raising senior capital. Information on other funding options available in the private capital markets will be addressed in future articles.

If you have any questions, please reach out to me at mtaffet@mastadvisors.com

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Mark Taffet is CEO of Mast Advisors, Inc., an M&A and strategic advisory firm focused on maximizing value for middle market companies. Information regarding specific aspects of the private capital markets has been provided by SPP Capital Partners, an investment bank focused on raising funds in the private capital markets.

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