Managing creditors during a cash flow shortage

As much as companies are pointing a finger at Covid-19 and citing it as a root cause of their financial distress, through our (Genesis Corporate Solutions) observation, many of these companies would find themselves in financial distress even if the Pandemic never took place.

It is imperative to point out that companies often face disruption, and it is not uncommon for the dynamics of a market to change so significantly that the rules of engagement are effectively changed. Companies need to manage this and be adaptable enough to change their operating models to address the challenges associated with this.

The fruit of financial distress is often seen in a company’s cash flow, a reflection of weaknesses in the operating model of any business. A poorly managed cash management system will put pressure on this which ultimately impacts creditors who are important stakeholders in the success of any business.

Behind preserving jobs, BRPs have a fiduciary duty to perverse the value of creditors. I recently read an article by universalfunding.com which provides some examples of how financially distressed companies can effectively manage creditors during times of crisis.

Assess the current situation
Working with BRPs or Turnaround Professionals, the article points out that the first crucial thing distressed companies need to do is not to bury their head in the sand. Yes, a cash flow shortage might resolve in time. However, creditors will be seeking payment when they fall due.

So, create a day-by-day cash flow forecast that includes all your debtors and creditors analyzed by the date that payments are due. This needs to be thorough because you can’t afford any surprises when you have no spare cash.

The article adds that when you have your daily cash flow forecast, you will know when creditors will fall due to when the most severe shortages will occur. Then, you can contact creditors before they enquire about the status of their payment, which is always a better way of managing late creditor payments.

Assess the likelihood of recovery
The article points out that it is often not necessary to close a business that is going through a short-term cash flow shortage. However, it would be best if you were realistic about the prospects for a recovery and for the business to continue a going concern basis. So, revisit your long-term budget and cash flow forecast and assess the likelihood of the company surviving. It is at this stage that a company going through financial distress looks at the budget and business model reviews in association with a BRP or Turnaround Professional.

The article adds that the current lack of cash may impact things like sales forecasts. For example, you may not be able to afford hiring staff that you had previously anticipated, and you may not be able to purchase all the raw materials of products for resale to support a high level of sales. So, your emergency budget and cash flow will need to reflect the impact of the lack of working capital.

Consider options for generating cash fast
The article points out that, depending on the severity of the problem, you might want to consider ways of generating cash fast. Do you have any assets that you could sell, for example? Could you sell products at a discounted price without worsening the company’s financial position? Do you offer early settlement discount to your debtors?

You could also look at ways to reduce cash outgoings fast- cutting out on expenses. Cancel unnecessary subscriptions and contracts, for example. As a last resort you may want to consider reducing worker hours or laying off staff.

The article adds that if your business had a good track record before the current financial crisis, you might be able to get a short-term loan to see you through the shortfall. Another option that would liquidate your accounts receivable faster could be to sell outstanding sales invoices to a factoring company. However, to raise any additional financing, it would be necessary to demonstrate that the business is still a viable going concern.

Prioritize creditors
The Universal Funding article points out that the next step is to rank (prioritize) creditors in order of the critical role that they play in the survival of the business. So, the water cooler supplier, for example, will come at the bottom of the list, but vendors required to produce goods for sale would be at the top of the list.

When prioritizing creditors, it would also be advisable to consider the possible ramifications of non-payment. Not paying the South African Revenue Service (SARS), for example, could result in your company being closed and assets seized. On the other hand, it will take some time for a small, local supplier to escalate the debt collection to the point that legal action will be imminent.

The article adds that it would be best to avoid any action being taken against the company at all. Such action would affect the credit score of the business. So, the objective is to keep creditors at bay for long enough for you to resolve the cash flow problem.

Create a payment plan
The article points out that, based on your cash flow forecast and creditor prioritization, you can now create a payment plan. The aim is to pay or negotiate with the critical creditors first and then see what cash you have left for non-essential suppliers.

The article adds that you might find paying that one or a few sizeable creditors will eat up all your short-term cash. If that is the case, it might be best to attempt negotiating repayment plans with these sellers. If you can demonstrate that the cash flow crisis will be short-lived, suppliers may give you more time to pay. Some creditors may also accept part payment of debts if you can provide a firm date for the balance payment but keep your word.

Communicate with Creditors
The article points out that if you communicate and are honest with creditors, they will be more likely to be lenient. So, don’t ignore the phone calls, reminders, and collection letters. Instead, give firm payment dates when you can or suggest a realistic timescale for settlement.

The article adds that when dealing with significant critical suppliers, it is generally best not to use the usual excuses for non-payment of invoices. Vendors will have heard things like ‘the check is in the mail’ so many times before that they will see right through it. Plus, lying or making promises you can’t keep puts you on the back foot when the check fails to arrive, and you need to ask for another week’s grace.

Moses Singo is a Partner at Genesis Corporate Solutions and is a Junior Business Rescue Practitioner.