Case Study 1: The Cash Flow Forecast

FOUR WEEKS TO FORECLOSURE – WHY THE CASH FLOW FORECAST IS THE MOST IMPORTANT FINANCIAL DOCUMENT A COMPANY CAN PRODUCE - and why it is your “Pilot Dashboard”.

One of my clients was in hock to a bank, who had given them four weeks to come up with some payments on a note and create a believable plan to pay off the balance.  As is usually the case with companies operating in the red, this one did not have a cash flow forecast (or any of the other “best practices” reports recommended for operating at the highest levels of profitability). 

The goal was twofold – to find some sources of cash to satiate the immediate need, and identify how the company was going to become profitable, so that the bank would be better off supporting the pan rather than attempting to fund its note through a forced liquidation of assets.

In a “cash poor” situation, the easiest immediate source of funds is from people who already owe you money, and have chosen not to pay.  Again, typical of badly managed companies, this one’s average DSO was over 90 days, when a good target to aim for is less than 40.  So it was very easy to set the accounts receivable staff to work on the telephones identifying why customers had chosen to ignore their invoices, fixing errors, offering some minor incentives and generally keeping tabs on them on a daily basis to bring cash in the door.

While these collections efforts were taking place in one part of the office, I was working with what little financial information was available to create an estimate of future cash flows.  While the owners knew from their monthly financial statements (usually completed about two months in arrears) that they were spending over $1 million per month on payroll, they had no idea that about 40% of it was in overtime (wages paid on hours in excess of 8 in a day at a 50% premium).

In observing the working practices of the staff, it was clear that overtime, if it had been needed at a time when the company was growing, was certainly not needed now, but no-one had risen to the occasion to take control of the situation.  Staff were generally seen to be hanging around the break room, smoking behind the storage sheds, taking excessive lunch breaks, and doubling up on functions which were clearly able to be performed by one individual.  Overtime was seen as a “right”, but it was crippling the performance of the company, and was now potentially going to kill it.

An outright ban on overtime was immediately introduced, to much protest, but surprisingly to some, all the work got done in 40 hours.

The beauty of the cash flow forecast was that the changes in outgoings immediately taking place as a result of this change in working practice almost by itself led to positive cash flow, as payroll was such a large proportion of expenses.  However, what the cash flow forecast allows, in a dynamic manner, is to see how every expense stacks up in terms of materiality and timing.   Add a procedure to sign every check and not only do you begin to see where the money is going, unnecessary expenses will stop immediately once staff know there will be a review. 

At this particular company, the next largest recurring expense was transportation, and as a result of implementing route planning software, this number came down significantly.  But not only in terms of consumables such as fuel and maintenance.  The efficiencies generated led to a reduction in the fleet of 20%, together with further reductions in payroll, insurance, and depreciation.

Because the cash flow forecast is dynamic, and because in order to carry out a plan, you need to periodically review where you are and compare that with where you expect to be, it is wise to perform an analysis at the end of each week, month and year to see whether or not your assumptions were valid, and if not, make further changes.  Banks in particular like to know that if you told them on the first of January that at the end of the month, you would have $1 million in their account, that at the end of the month you do have those funds, or you have a very good explanation of why you don’t and what effect that will have going forward.

CONCLUSION

Because we were able to forecast an improving trend of profitability, by taking the steps identified above, in a rolling forecast, and meet all the expectations we had set for the bank, over the course of the assignment, this company went from being threatened with foreclosure to becoming highly profitable, and was ultimately sold for a good multiple of earnings.