Cash Flow Forecasting

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David Johnson is a career change agent who has served as interim manager or financial advisor on over $5 Billion of distressed middle market transactions.

In his nearly 20 years as a change agent, David has served as an advisor, board member, interim manager, investor and operator at organizations ranging in size from pre-revenue startups to Fortune 500 organizations.

David has several publications to his credit and is a regular speaker on the topics of change management, performance improvement, turnaround and restructuring. He received his MBA from the University of Chicago and completed his undergraduate studies at Fairleigh Dickinson University.

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Cash Flow Forecasting

  1. 1. Cash Flow Forecasting Speaker: David Johnson September 15, 2011 1
  2. 2. Session Overview • Company Overview & Speaker Bio • Forecasting Concepts • Warning Signs • Hypothetical Case: NoneSuch, Inc. • Creating a Robust Forecast • Q&A 2
  3. 3. Opening Words • “Some people seem to think there's no trouble just because it hasn't happened yet. If you jump out the window at the 42nd floor and you're still doing fine as you pass the 27th floor, that doesn't mean you don't have a serious problem.” – Charles Munger, Vice Chairman Berkshire Hathaway 3
  4. 4. Company Overview • ACM Partners is a Chicago-based boutique crisis management and investment firm serving companies and municipalities facing current or impending financial distress. • The advisory services of ACM Partners are centered around the concept of crisis management. • We define a crisis situation as one in which either the current state of affairs or the trend, left unaddressed, threatens the viability of a company. • As crisis managers, we view our role as preserving and growing enterprise value. In short, a company in crisis is a melting ice cube, and it is our job to turn down the heat enough so that ice first stops melting, then begins to grow again. 4
  5. 5. Speaker Biography • David Johnson is a finance professional with more than 10 years of experience in business plan development, business process optimization, restructuring, and turnaround. • David earned his Master of Business Administration from the University of Chicago with concentrations in Accounting and Finance. • With engagement experience spanning North America and involving companies ranging in size from pre-revenue start-ups to nearly $1 billion in sales, David has shown the flexibility to thrive in the dynamic situations that are a constant in turnarounds. 5
  6. 6. Forecasting Concepts • A 13-week cash forecast (“TWCF”) is a tactical tool that allows all stakeholders to understand the actual sources and uses of cash on a weekly basis. • A TWCF eliminates the “noise” in an income statement by focusing on cash receipts and disbursements. – Instead of revenue, the focus is on cash receipts – Instead of COGs and expenses, the focus is on disbursements by natural accounts (i.e. accounts that are intuitive: materials purchases, labor, rent, etc.) – This approach removes many of the timing issues associated with the income statement and allows for an analysis of intra-month liquidity swings 6
  7. 7. Forecasting Concepts Cont. • The granularity of a TWCF permits management and advisors to adjust the timing of payments to better manage cash flow. – What receipts can be pulled forward? What disbursements can be delayed? • The TWCF places the focus on the situation as it is, not as it should be. – When do customers actually pay? – When are vendors actually paid? • By incorporating a working capital forecast for those companies funded with an asset based revolving line of credit, a TWCF provides a fairly comprehensive view into a company’s total borrowings relative to borrowing base, and as such serves as an early-warning system for lenders that a company may be in an over-advance situation (i.e. borrowings exceed borrowing limit). 7
  8. 8. Weekly Cash Reporting • Weekly variance reports can highlight issues with a forecast as well as ensure management accountability. • Variance reporting is also valuable as a means of rebuilding trust between management and lender. 8 NoneSuch Inc. Variance Report ($ in 000s) Week Ending 7/9/11 Actual Budget Variance % Var Note Sales 1,608$ 1,636$ (28)$ -1.7% Unanticipated sales weakness Receipts Trade Receipts 1,673 1,701 (29) -1.7% Key customer delayed payment Cash Sales 159 164 (4) -2.7% Issue unclear, to be investigated Total Cash Receipts 1,832 1,865 (33) -1.8% Operating Disbursements Inventory and Material Purchases - - - N/A Critical vendor paid early, temporary variance Labor Costs 1,398 1,361 37 2.7% Variance is de minimus Real Estate Leases 196 196 0 0.2% Equipment Leases 300 300 - 0.0% Sales & Use Tax 80 80 - 0.0% Insurance - - - N/A Property and Other Taxes - - - N/A Professional Fees - - - N/A Capital Expenditures - - - N/A Critical repairs on machinery, permanent variance Other 63 60 3 4.8% Cost controls are lowering this item, permanent varience Total Operating Disbursements 2,037 1,997 40 2.0% Non-Operating Disbursements Interest - Revolver - - - N/A Other Bank Charges - - - N/A Professional Fees - Restructuring - - - N/A Retainer for legal counsel Accounts Payable pay down 17 15 2 10.0% Other - - - N/A Total Non-Operating Disbursements 17 15 2 10.0% Net Cash Flow (222) (147) (75) 51.0%
  9. 9. Forecast Dictates Options • Turnarounds are about cash and time, and TWCFs provide turnaround professionals with the information to answer key questions. – Are things getting better or worse? – What is the peak cash need (and is it in excess of current funding available)? – Is this a case of “good company, bad balance sheet,” or is this just a bad company? – Is there time for an orderly sale process? • A robust TWCF will answer these questions, and in doing so, guide key decision-makers on the appropriate course of action. – Pursue a turnaround or liquidation – Seek to reorganize (either out-of-court or in chapter 11) – Liquidate (worst-case scenario) 9
  10. 10. Assessing Viability Turnaround Candidate • TWCF shows a manageable peak cash need (i.e. lender or other stakeholder is willing and able to “fund the burn”) • There is a clear short-term path to reach operating cash flow break-even • Given a successful turnaround, company has a future with current stakeholders (i.e. owners’ equity not wiped out in plausible upside scenario, lender fatigue has not set in) Liquidation Candidate • TWCF shows a peak cash need in excess of what lender or other stakeholder is willing or able to commit • No clear path to reach operating cash flow break-even • Owners’ equity wiped out in any plausible scenario, lender fatigue has set in, no interest from outside parties in going- concern sale 10
  11. 11. Restructuring (In vs. Out-of-Court) Out-of-Court Restructuring • Stakeholders are in relative agreement on the value of their positions • There are no substantial issues involving employees (current or former), landlords, tax liabilities, trade creditors, etc • Non-DIP funding has been secured / is available to complete the turnaround Chapter 11 Bankruptcy • Stakeholders are unable to agree on the value of their positions • There are issues involving employees (current or former), landlords, tax liabilities, trade creditors, etc • Non-DIP funding has not been secured / is not available to complete the turnaround 11
  12. 12. A Sale Process, But What Kind? • In the last down cycle (2008-2010), many restructurings, especially chapter 11 filings, ended in a sale process. However, knowing that there will be an M&A component to a restructuring is not the same as knowing what type of sale process will be necessary. – A distressed company could run out of liquidity prior to the close of a traditional sale process – The TWCF will allow turnaround advisors and investment bankers match the tempo of a sale process to the amount of time available 12
  13. 13. Warning Signs • Managing to a TWCF is not intuitive for most companies, and it is a rare management team that does not (initially) resent the intrusion of a turnaround advisor espousing what is, for them, a new and alien financial tool. • With management teams unclear on the benefits and resentful of the intrusion, the task of acknowledging the need for, and recommending, a turnaround advisor generally falls to one of three groups: – Capital Providers (bank and non-bank lenders and private equity firms) – Investment Bankers – Attorneys • It is important for all of these parties to be aware of key warning signs that a TWCF is necessary. 13
  14. 14. Warning Signs Cont. 1. Sales Weakness: Due to the lag between sales and collections, the cash impact of missed sales targets could lag a drop-off by several months. This lag presents a valuable opportunity for a company and its stakeholders to proactively address a developing problem. 2. Input Cost Volatility: Increased demand from emerging market countries has driven substantial volatility in commodities prices in recent years. This high level of volatility represents a considerable risk to margins. 3. Ill-Fated Expansion Initiatives: In our current low / no growth environment, the temptation for companies to find some way, any way, to return to growth is strong. Occasionally these initiatives become considerable drains on liquidity and need to be acknowledged as such. 14
  15. 15. Case Overview • NoneSuch is a construction supply company located in the Chicago metro area. While it had managed to weather the real estate downturn, it did suffer considerable gross margin erosion. • Management’s CY 2011 forecast showed another year of losses. The company’s lender was initially satisfied that proper steps were being taken, and continued to monitor the situation while not insisting on a turnaround advisor. • Beginning in June, however, NoneSuch’s lender became concerned that the company was stretching vendors to conserve cash, and that the company’s liquidity situation was deteriorating rapidly. • The lender suggested, and NoneSuch retained, a turnaround advisor to create a TWCF and advise. 15
  16. 16. Financial Forecast • NoneSuch management acknowledged weak business conditions, and their forecast showed losses. The company’s lender was concerned that the liquidity situation was even worse. 16 NoneSuch Inc. Sales Forecast ($ in 000s) Period Q1 Q2 Q3 Q4 FY Sales 19,540$ 20,837$ 19,540$ 20,837$ 80,754$ Cost of Goods Sold 14,557 15,003 14,948 15,003 59,511 Gross Profit 4,983 5,834 4,592 5,834 21,243 Margin 25.5% 28.0% 23.5% 28.0% 26.3% SG&A 5,988 6,163 5,988 6,163 24,302 EBITDA (1,005) (329) (1,396) (329) (3,058) Margin -5.1% -1.6% -7.1% -1.6% -3.8%
  17. 17. 13-Week Cash Flow Forecast • The high level of granularity inherent in a TWCF gives all stakeholders a better picture of short-term liquidity pressures, and their causes. 17 NoneSuch Inc. 13wk CF Forecast ($ in 000s) Week Number 1 2 3 4 5 6 7 8 9 10 11 12 13 Week Ending 7/9/11 7/16/11 7/23/11 7/30/11 8/6/11 8/13/11 8/20/11 8/27/11 9/3/11 9/10/11 9/17/11 9/24/11 10/1/11 Sales 1,636$ 1,636$ 1,636$ 1,636$ 1,731$ 1,731$ 1,731$ 1,731$ 1,214$ 1,214$ 1,214$ 1,214$ 1,214$ Receipts Trade Receipts 90.0% 1,701 1,071 1,071 1,071 1,071 1,071 1,472 1,472 1,472 1,472 1,558 1,558 1,558 Cash Sales 10.0% 164 164 164 164 173 173 173 173 121 121 121 121 121 Tax Receipts 103 103 103 103 103 103 103 103 103 103 103 103 103 Total Cash Receipts 1,968 1,337 1,337 1,337 1,346 1,346 1,748 1,748 1,696 1,696 1,782 1,782 1,782 Operating Disbursements Materials Purchases 1,361 1,361 1,361 857 857 857 857 857 1,252 1,252 1,252 1,252 1,324 Labor Costs 196 196 196 196 203 203 203 203 162 162 162 162 162 Real Estate Leases 300 - - - - 300 - - - 300 - - - Equipment Leases 80 - - - - 80 - - - 80 - - - Sales & Use Tax - - 327 - - - 360 - - - - 381 - Insurance - 45 - - - - 45 - - - 45 - - Property and Other Taxes - - 1,380 - - - - - - - - - - Professional Fees - - - - - - - - - - - - 75 Capital Expenditures 60 60 60 60 60 60 60 60 48 48 48 48 48 Other 8 8 8 8 8 8 8 8 6 6 6 6 6 Total Operating Disbursements 2,005 1,670 3,332 1,120 1,127 1,507 1,532 1,127 1,468 1,848 1,513 1,849 1,615 Operating Cash Flow (37) (333) (1,995) 217 219 (161) 216 621 229 (151) 269 (67) 167 Total Non-Operating Disbursements 15 15 15 15 15 15 - - - - - - - Net Cash Flow (52) (348) (2,010) 202 204 (176) 216 621 229 (151) 269 (67) 167
  18. 18. Head-to-Head Comparison Advisor TWCF 18 Management Forecast NoneSuch Inc. Sales Forecast ($ in 000s) Period Q3 Sales 19,540$ Cost of Goods Sold 14,948 Gross Profit 4,592 Margin 23.5% SG&A 5,988 EBITDA (1,396) Margin -7.1% NoneSuch Inc. 13wk CF Forecast ($ in 000s) Week Number Total Week Ending Forecast Total Cash Receipts 20,905 Total Operating Disbursements 21,712 Operating Cash Flow (807) Total Non-Operating Disbursements 3,395 Net Cash Flow (4,202) Availability (Over-Advance) (557) Maximum Over-Advance DSO 62.3 Maximum Value Inventory Turns 11.2x Minimum Value DPO 49.3 Ending Value Sustainable DPO 50.0 Ending Value Implied Vendor Stretch 2,471 Maximum Vendor Stretch
  19. 19. Outcome • Following the creation of a TWCF, the turnaround advisor was able to work with NoneSuch management and its lender to pay down vendors in an orderly manner and manage through a liquidity squeeze. • The turnaround advisor indicated that NoneSuch was likely to experience further liquidity pressure in the medium-term, and recommended that an investment banking firm be retained to manage an orderly sale process. • Through proactive identification of warning signs, considerable enterprise value was preserved. 19
  20. 20. Ask Questions • Operating: – A current income statement forecast – What is the breakdown of sales (% cash, % trade credit)? Is this constant or does it vary? – Understanding of working capital trends (does A/R typically get paid evenly throughout the month, are collections lumpy, etc) – Understanding of any timing issues for disbursements (is rent always paid on the same day, when is sales and use tax due, is fixed labor paid bi-weekly and variable labor paid weekly, etc) • Non-Operating: – Are any lender fees due as a result of default? – What is the cost of professional fees associated with a restructuring? – Is A/P stretched and requiring pay down? – Is an equity infusion being considered? – Is sale-leaseback or other monetization of assets under consideration? 20
  21. 21. Ask Questions Cont. • Borrowing Base: – What is the borrowing base limit? – What are the advance rates for A/R and Inventory? – Is M&E included in the borrowing base? – How are ineligibles calculated? – Are there any additional reductions to availability (letters of credit, hedging settlement, etc)? • Any areas of weakness in an initial forecast will be resolved through analysis of variances between actual and forecasted values. 21
  22. 22. Closing Words • “The best advertisement for our value is a list of clients who no longer need us.” – Margaret Bogenrief, Partner ACM Partners 22
  23. 23. About ACM Partners • ACM Partners is a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services. • David Johnson can be contacted at: – Email: david@acm-partners.com – Ph: 312-505-7238 • For more information visit: www.acm-partners.com. 23

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