COVID-19 and Cash Flow Forecasting: Buyer Beware

By Rishi Jain, Head of Performance Improvement & Restructuring Solutions, Co-Head of Western Region and Jubin Pandey, Vice President

Private equity sponsors don’t think a cash flow analysis will cure what ails their portfolio companies. They do, however, believe it’s the best first step toward creating a treatment plan that will help right the trajectory of once healthy investments now at-risk.

And they’re correct. But, it’s not the same 13-week analysis they’re used to.

The typical version is primarily for companies not meeting expectations based on projected performance. It uses static inputs from Treasury to create a liquidity outlook over a finite, few-weeks period of time. It’s premised on specific assumptive data used for singular scenario planning.

Thomas Friedman recently argued that “the coronavirus will create a new historical divide: before-Corona (BC) and after-Corona (AC).”  

In the AC period, there are no reliable projections; market realities are volatile and uncertain. Cash flow analysis should be oriented less toward restructuring and more toward reassessing (and sometimes resuscitating).

Portfolio companies responding to COVID-related disruptions therefore need:

• Modeling, not Forecasting: Models are dynamic, automated tools that enable management to re-use the underlying analysis, isolating different variables as company performance or market realities change. The AC model enables management to understand the impact of X (a change in revenue, disbursement, budgeting reforecasts) on company liquidity.
• Everybody, not Treasury: The 13-week forecast is built on the strength of the inputs from Treasury. Treasury is a critical stakeholder, but when it’s the only stakeholder, the analysis is one dimensional. The AC model brings together insights from all relevant parties, including the CFO (financial and covenant reporting), FP&A (budget, financial income statement and balance sheet roll-up, sales projections); Controller (trial balance, cash roll-up, G/L accounts, bank reconciliation); Procurement (vendor details, purchasing plan, open purchase orders); AP (disbursement execution and tracking); Sales (pipeline and backlog visibility, CRM); AR (order-to-cash, collection); HR (employee-related costs); IT (automation and data integrity). When done right, the cash flow analysis will also include input from stakeholders within the business (department heads, lines of business managers), who must buy-in to the exercise in order to champion the liquidity management strategy that will be informed by it.
• Flexible, not Fixed: The BC approach to cash flow analysis is typically used in bankruptcy and out of court restructuring situations, where the 13-week timeline is appropriate. The time period for COVID and downside-related cash flow modeling must be more fluid. Yes, some red zone portfolio companies need only the week ahead outlook, but the far majority of portfolio companies will benefit from a model that can flex up or down from 13 weeks to 52 weeks, enabling a more holistic and longer-term view of company liquidity. These models still answer the urgent daily cash planning questions present in tight liquidity scenarios (e.g., Can we make payroll?), but they also provide foresight for companies with the possibility of a longer leash.

Doing cash flow analytics well does not require more time or sponsor investment.

It does require a different perspective. It requires an operational finance lens. It requires experience building an integrated approach inclusive of multiple stakeholders. It requires expertise working with granular and often large data inputs. It requires a sophisticated approach to developing and identifying the right level of KPIs. It requires an understanding of both performance improvement scenarios as well as insights drawn from working with healthy companies – where longer-term scenarios abound, and where collaboration with FP&A is key. It requires a business process mindset for weekly actualization and accountability.

Choosing the right kind of cash flow analysis (integrated, dynamic modeling) can inform the success and efficacy of downside scenario planning. Of course, conducting any kind of cash flow analysis is only the first step in a company’s liquidity journey. The next, critical step must be to act on its insights. That could mean pulling the right value creation levers to ensure companies in the green remain there. It could mean value stabilization initiatives for at-risk (yellow) companies. Or, as is increasingly the case in the AC environment, triaging those companies that are blinking red. But that’s for another article…