Our last article addressed the basics of the phased return to the new normal, and outlined the importance of understanding working capital impacts and funding needs as companies go through the phased reopening process.
Considering working capital and cash management with the backdrop of the coronavirus is complicated. Let’s work through a few examples.
Accounts Receivable
In the first example, consider ABC company that provides materials to the restaurant industry. The restaurants went to extended payment terms as soon as ABC complied with the government shut down requests, resulting in ABC experiencing at least a 30 day extension for payments. Once the phased opening of restaurants occurs, the restaurants will not be back to normal operations, and will continue to request extended terms from ABC. ABC will want to keep its customers in order to increase the likelihood of collection and ongoing relationships.
In an example of a manufacturer of automative parts (QRS), their customers have completely shut down during and product is not moving through the pipeline. As a result, payments have been extended, especially since the parts are special purpose and QRS is unable to sell the product to others. QRS will be holding both accounts receivable and inventory, and has less ability to influence payments because they are not a single source provider.
Inventory
ABC has a shortfall of chemicals and cleaning products that its customers need, but has plenty of product that cannot be sold because people are not eating in the restaurants. Once the phased reopening occurs, product can begin moving again but the MIX of products being sold will not return to normal quickly. The mismatch of inventory will continue. ABC will have to locate sources for the product that is in high demand, and will find other products to be slow moving. This will slow down the inventory turnover overall, and will increase throughput needs for certain products.
For QRS, they have special purpose inventory that will not be needed until the automobile manufacturers are back on line and use their own existing stock. QRS will be able to return to selling product, but timing will not return to normal as everything, down to the car dealers and the financing sources, will need to be back to work and functioning. Consumers may delay purchase of large ticket items until some stability in work and normalcy occurs. QRS may have trouble sourcing raw materials during a restart, as its suppliers may be having their own difficulties. This could result in a mismatch of the materials needed to manufacture products.
Accounts Payable
Vendors to companies are calling constantly to request payments to generate their own cash flow. Companies are trying to maintain working relationships with suppliers for products that can be sold during the shut down and during the first phases of the return to the new normal. Companies are trying to protect their vendor relationships and trying to help their business partners.
ABC will be tempted to pay all of its vendors a little to keep everyone happy, but it may need to target only key suppliers and end of looking for new vendors for other items. ABC may be forced to pay for some slow moving product in order to ensure a supply of fast moving product. Rather than being able to do a COD approach with vendors, it may be requested to pay extra with each shipment in order to keep the fast moving product flowing through the system.
QRS may be required to pay certain client approved vendors in able to ensure QRS will be able to restart its manufacturing. It will be difficult to balance vendor needs, customer requirements, and cash flow.
The Intertwined Cycle
One company’s accounts receivable is another company’s accounts payable. One company’s sales are another company’s inventory. More than ever before, all businesses are intertwined in struggling with financial performance and working capital management.
ABC’s receivables are from restaurants. Restaurants need consumers to generate their credit card receipts. Consumers will be slow to go back into tight spacing.
QRS needs vendors to provide materials for manufacturing, and needs the car manufacturers to be building cars. The car manufacturers need dealers to be back operating, financing to be available, and consumers to be comfortable spending their money or taking on debt.
The playbook that was used in the past by companies to manage working capital and by lenders to deal with working capital issues is at best a starting point, but the old playbook does not fully address the current situation.
To make it more personal, let’s consider interaction with Amazon under Covid-19. Prior to Covid we could order products and receive them the next day. We were trained to wait until the last minute to order our supplies. We paid when shipped and we received anything we wanted right away. Now many items are sold out – we will need to keep larger inventories of supplies on hand, and we will need to use our cash to keep needed levels on hand. When Amazon doesn’t have products, we need to find alternative sources and then pay extra for shipping or encounter time delays. We have to substitute products we prefer with products that are available. If we have to pay more for products, we do that to ensure we have what we need.
These are the same issues every company is going to experience as it phases back into operations. And, all companies are going to experience this at the same time.
Working Capital Management Ideas
Make sure the sales and marketing team are over communicating with their customers. A company will gain insight into accounts receivable payment patterns, changing purchase orders moving forward, and inventory status at the customer level.
The company’s management team needs to be meeting at least weekly to address vendor relationships and payment requests. A company will need to prioritize who to pay based on current needs for product, potential single source issues after the phased return begins, potential sourcing volume problems after the phased return.
Vendors should be identified with a priority code using these concerns. Alternative vendors need to be identified and accounts established.
Inventory should be identified with a priority code and turnover rates by SKU need to be considered and adjusted. Substitutions should be identified where possible.
Companies with higher levels of liquidity entering February will be in a better position to weather these changes. But, companies will be experiencing degrees of stress irrespective of their liquidity.
The weekly cash flow and borrowing base forecast will be the key management tool going forward. CFOs and controllers need to have a base forecast built on what is currently known. Then the CFOs and controllers need to make adjustments in real time to see how a change in a customer’s payment impacts the ability to pay for supplies or for expenses.
Chaos and stress will be the normal environment. We need to understand that and develop ideas to reduce stress. Planning and organization are key. We make sense of chaos all the time – call us. We can help companies deal with this situation and work with lenders and owners to develop the recovery plans and liquidity goals needed.
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