Responding to the financial impact of the COVID-19 shutdown and disruption requires a firm, unemotional response at a time when that is most difficult to achieve. In this article on working capital management, Focus Management Group addresses techniques and approaches for managing each of the components of working capital, and then bringing all that analysis together in a working capital cash flow forecast.

It will become clear how intertwined businesses are with each other, and how each aspect of cash flow management affects the other parts of the business. The tools one business considers when managing its own accounts payable are the tools its vendors will use when managing their accounts receivable. And so, the circle of interrelationships grows.

Because all businesses have experienced some level of disruption and uncertainty, the hard core approaches to working capital management taken in the past will require additional planning and finesse as the economy returns to business.

To return to business, each company is going to need a weekly cash flow forecast that encompasses the hard work of planning and forecasting accounts receivable cash inflows, inventory needs and ability to generate cash, and accounts payable outflows. This planning comes together in the weekly cash flow forecast, including roll forwards of components of working capital.

While the cash flow model deals with cash inflows and outflows overall, it is most accurate when the direct drivers of working capital are forecast via roll forwards of accounts receivable, inventory and accounts payable. Even if the company does not have an asset-based lending structure, in this current environment, every business is best served if it operates with that level of discipline.

We identify these planning tools that drive the cash flow as:

• Accounts Receivable Planning and Management Tool,
• Customer and Product Profitability Tool, and
• Accounts Payable Planning and Management Tool.

Focus Attention on Accounts Receivable

The management of accounts receivable during the phased return to the new normal is a delicate balance of maintaining customer relationships and maintaining cash flow for survival.

Collecting cash is going to be extremely important during this time period, to ensure your company’s ability to continue to operate after business returns. At the same time, you need to maintain business relationships to keep the flow of information and the flow of cash coming.

How do you help your finance and accounting staff, or your sales and marketing staff, deal with collections calls they have to make to customers?

Provide a road map for your staff to use in making these outgoing collection calls. Develop a script for your staff. Address topics such as:

• Show empathy.
• Assure customers that your company is responding to the COVID-19 situation, and will be able to fill customer needs as long as a plan to work together regarding cash payments is created.
• What is the customer’s current level of your product in their inventory? When will they need product again?
• What is the customer seeing happening in the next two weeks? What do they anticipate in the 13 weeks?
• Explain you need assistance in helping to anticipate their needs, and you need a plan to receive cash to protect your ability to be there for them after the return to business.

How do you plan your cash payments?

Plan your cash receipts on a weekly basis. Develop your Accounts Receivable Planning and Management Tool. We recommend that a company reviews its accounts receivable with emphasis on developing the spreadsheet tool to address the following:

• Current customer contact information – name, title, phone number, email address.
• Accounts receivable aging information – total dollars owed by aging category.
• Existing payment terms with the customer – from the purchase orders or invoices.
• Historic payment practices for each customer – weekly, monthly, on due date, paid at 30 days, etc.

Now for the payment decision-making process, ask these questions and include the information in your Accounts Receivable Planning and Management Tool.

• Is this an ongoing customer? Will they be able to place orders in the next two to three weeks? Will they be able to place orders in the next 13 weeks?
• What is the purchase velocity expected per week? What is the needed delivery frequency?
• When is the next delivery needed?

Use this information in conjunction with the current business situation. Compare and coordinate the information between:

• What are your vendors able to provide for your production?
• What inventory do you have on-hand to meet the orders?
• Does your production schedule allow you to meet orders?

Be sure to consider:

• Is your company the single source of a product that the customer needs?
• Is your company an approved vendor requiring end customer approval for substitution?
• What are your competitors experiencing?

Once that information is accumulated, critical decisions will need to be made.

With the accounts receivable information that has been accumulated, the next step is to forecast how to anticipate weekly cash receipts. Using the Accounts Receivable Planning and Management Tool developed using the criteria outlined above will provide guidance for dealing with collecting receivables from customers.

How is the planning tool used?

Customers will be ranked based on the criteria identified earlier, and deliveries will be forecast by individual customer. Categories of customers should be developed with different collection strategies.

The most important customers will require additional planning and payment latitude. Consider requesting payments based on products being shipped in. Use the COD theory to bring $100,000 of cash in for every $100,000 of product delivered.

Consider payment schedules with frequent payments to gauge commitment and ongoing needs.

Consider return of product to reduce receivables and allow product to be sold to other companies that would be able to pay.

Ask the company to sign a note for extended payment schedules.

Consider changes to terms offered. Discounts could increase payments.

Consider the impact on asset-based lending relationships?

Forecast the accounts receivable by customer, and roll the customer and the overall accounts receivable forward. This will allow analysis of customer concentrations and accounts receivable aging impacts. This is especially important when forecasting ability to borrow under a line of credit. But, it is also important for any business to understand its customer concentrations, and when it may be serving as a lender to its own customer.

Focus Attention on Inventory

The management of inventory during the phased return to new normal is more difficult than managing inventory during ongoing routine operations.

The first step is determining what customers will need to buy and when the purchase orders will be coming, and deliveries of product will be required. Purchasing rhythms that were repeated before COVID-19 cannot be expected to return quickly, if the pattern returns at all. The sales and marketing staff of a company need to be contacting customers on a regular basis to understand each customer’s unique needs during the phased return to the new normal. Different geographic regions will be returning at different rates and in different ways. A company must understand its customers’ needs in the immediate term – beginning with two to four weeks, and then looking forward to 13 weeks.

How do you help your staff identify customer needs?

Provide an outline of what you need your sales and marketing staff to identify. Develop a script for your staff. Address topics such as:

• What is the customer’s current level of your product in their inventory?
• What is the customer seeing happening in the next two weeks? Ask for a regular planning call on at least a weekly basis.
• How does geography impact purchasing needs?
• Assure customers that your company is responding to the COVID-19 situation, and will be able to fill customer needs.
• Explain you need assistance in helping to anticipate needs.

Communication is key during this time. Customers will be hesitant to commit to purchases. But, it is possible to anticipate needs if you understand what your customers are experiencing.

What analysis is critical now?

Companies will experience working capital stress during this phased return to business. It will be important to decide where to invest dollars. This is the time to understand customer and product profitability, and to understand what changes are taking place as businesses return to work.

The combination of understanding customer and product profitability will allow your company to return to business with the best mix of customers and products that is possible. This is the time to use your Customer and Product Profitability Tool, or it is time to create one. We recommend a company review its products and customers to identify:

• Phased in volumes of specific products, initially over a two- to four-week period and expanding out to a quarterly analysis.
• Understanding run rates during the next quarter.
• Identification of fixed and variable costs, at the new levels. Consider revised staffing, additional costs for testing and supplies, and other changes that will be expected moving forward.
• Identify product mixes that will be required based on conversion from raw materials to finished goods to sales to cash.
• Re-evaluate raw material costs.

This is also the time to evaluate vendors.

It will be important to also understand vendors from these perspectives:

• For any single source vendors, identify alternative sources, if possible. Establish new relationships where practical.
• For any long-term single source vendors, talk to the vendors to determine their ability to meet your demands. Their ability to supply product may limit your ability to meet customer needs.
• Work with vendors to provide short-term and intermediate-term suggestions of your activity with them.
• Identify any supplier line of credit issues, and talk with vendors before problems surface.

Converting inventory to cash.

The COVID-19 impact on a company’s inventory can be enlightening. Most companies have a group of inventory items that turn quickly, and move through the company consistently. Most companies also have a subset of inventory that has aged out or turns very slowly. The subset of slow moving inventory is to a large extent masked during normal operations, and many ABL facilities do not age inventory in the same way receivables are aged.

This is the time to identify slow moving or stale inventory and convert that inventory to cash. While the borrowing base may be impacted if that slow moving or stale inventory has not been classified as ineligible, that negative effect needs to happen to generate cash from inventory that cannot otherwise be converted to cash. Selling $1 million of stale inventory for 50 percent, generates $500,000 of cash to use right now to repay a line of credit or to purchase needed inventory.

This is the time to identify any rebalancing of inventory. Over time inventory purchasing timing and base quantities for production change. If your company has not recently analyzed and rebalanced inventory, this is a good time to update that analysis – including new information on quantities and products from the sales and marketing staff’s discussions with customers. Changing the inventory mix to improve turnover by even two or three days of sales can have a material impact on cash flow. At a daily sales level of $150,000, shortening the operating cycle by two days generates $300,000.

Identify changes to lead times that may affect the flow of needed inventory through manufacturing or distribution.

Use all of this information to generate an inventory roll forward.

Focus Attention on Accounts Payable

The management of accounts payable during this phased return to the new normal is critical. A company’s finance and accounting staff is receiving more frequent and more intensive collections calls from the suppliers. Even a company with a history of prompt payment is concerned about cash right now and is feeling the stress, therefore, suppliers are asking their staff to quite literally dial for dollars every day.

How do you help your finance and accounting staff deal with the collections calls?

Provide a road map for your staff to use in responding to calls. Develop a question and answer tool – a script for your staff. Your employees need answers they can share with callers. Address topics such as:

• Show empathy.
• Explain there is a payment plan being developed that will be coordinated by the senior management of the company.
• Assure vendors that payment is important to the company, and a plan is being developed.
• Provide a time line for return calls, and keep call notes to summarize discussions.

How do you plan your cash payments?

Plan your cash payments on a weekly basis. Develop your Accounts Payable Planning and Management Tool. We recommend that a company review its accounts payable with emphasis on developing the spreadsheet tool to address the following:

• Current vendor contact information – name, title, phone number, email address.
• Accounts payable aging information – total dollars owed by aging category.
• Existing payment terms with the vendor – from the purchase orders or invoices.
• Historic payment practices for each vendor – weekly, monthly, on due date, paid at 30 days, etc.

Now for the payment decision-making process ask these questions and include the information in your Accounts Payable Planning and Management Tool.

• Is this an ongoing vendor? Will you need this vendor in the immediate term?
• What is the purchase velocity expected per week? What is the needed delivery frequency?
• What is the level of inventory on hand?
• When is the next delivery needed?

Use this information in conjunction with the current business situation. Compare and coordinate the information between:

• What do the customer purchase orders indicate customers will be needing?
• What inventory is on-hand to meet the orders?
• What is the production schedule that will be required to meet orders?

Be sure to consider:

• Is this vendor the single source of a product that is needed?
• Is this an approved vendor that a customer would need to approve for substitution?
• Are there alternative vendors?

Once that information is accumulated, critical decisions will need to be made.

With this accounts payable information that has been accumulated, the next step is to forecast how much cash is available to pay to vendors each week. Using the Accounts Payable Planning and Management Tool developed using the criteria outlined above coupled with the cash flow forecast, a company will need to come up with a payment schedule and plan for its vendors.

How is the payment schedule used?

Vendors will be ranked based on the criteria identified earlier, and payments will be forecast by individual vendor. Categories of vendors should be developed with different payment strategies.

The most important vendors will require frequent payments based on products being shipped in.

The least important vendors will need to have a payment schedule after business returns to the new normal.

Once the payment plan is outlined, the approach to working with vendors should be divided into groups for communication management. For example, the most important vendors should be communicated with by higher level people in the organization or by the people that have the best relationship with the vendor.

These are the vendors that will directly result in increased sales, receivables and cash for the company.

Cash Planning: Is a Weekly Cash Flow Needed?

The importance of a weekly cash flow model has never been greater.

The key for a successful phase back into operations is a working capital plan, with a weekly cash flow forecasting tool as the roadmap.

A company needs to use its accounts receivable to forecast cash receipts, and then forecast its expenses. Consider additional sources of cash, such as the Payroll Protection Program (PPP) loans, disaster loans, the Main Street Lending Program or owner investments.

Next Steps

This level of planning can seem monumental, but it is extremely important now. We all have to manage cash as closely as possible, but also provide a roadmap to the return to new normal. Employees, customers, vendors and bankers will all be happier with a roadmap that outlines what will happen. The initial work to develop the roadmap, and utilize these planning tools, can be overwhelming. But, once implemented, if these tools become part of the company’s planning structure, success should be maximized.

We are ready to help companies work through their cash flow forecasting and develop their roadmap to the return to new normal. We are able to work with companies to build their working capital planning skills, culminating in a weekly cash flow forecast with regular ongoing budget to actual reporting.