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Column

Deborah Hicks Midanek
President
Solon Group Inc.

Understand the Cash
A board may be comfortable that the company has the resources to withstand a storm. Turnaround pros may come to a different conclusion.

By Deborah Hicks Midanek

In almost 30 years of working with troubled companies, I have never yet seen a company that has a good understanding of its cash.

Executive time is typically spent on important bank and capital market relationships, and on financial reporting. Cash management is typically a clerical function, not part of regular management scrutiny.

The board, not burdened with daily running the business, can assist on this, and through this continuing process help both management and board better understand the company’s business dynamics. Greater understanding of the critical drivers of cash through the business leads to greater confidence when the unexpected inevitably occurs.

How to do this?

The First Step on Arrival
The first thing a turnaround manager does on arrival in a new situation is to figure out as fast as possible how much cash there is, where it is, and who has what claims on it, typically working from the general ledger and actual receipts and disbursements.

A rolling cash flow forecast is typically created, covering, for example, 16 weeks forward, and including receipts, disbursements, use of working capital, and taking into account major debt and capital expenditure payments.

Understanding the flow of cash allows the turnaround team to estimate how much time there is to identify and address sources of difficulty, and how broad the range of possible options might be.

In one recent subprime mortgage originator situation, I arrived at a company that had $600 million in cash on its books and a board comfortable that they had the resources to withstand the storm. On a quick look, all but $15 million of that cash was encumbered, payroll was in jeopardy, and an immediate filing was inevitable.

A company can appear to have more than adequate resources when looked at on a financial reporting basis, but GAAP interpretation can often disguise the availability of cold hard cash. It is a very good discipline for that cash flow forecast, and related “flash reports” on key variables the board wants to track, to become part of every board package.

Creating the Financial Model
The next thing the turnaround manager does is work on creating an integrated financial model, tying the cash flow to profit and loss and to the balance sheet.

Typically, financial and management reports are periodic snapshots and do not focus on constant improvement of understanding key drivers and their integration. The key is to continue actively to work on constantly improving the model against the actual numbers that the company generates. This can lead to tremendous insight and a very good early warning system that will allow both board and management attention to focus on key measures quickly, with confidence.

By comparing the model to budget and actual results each month, the model not only improves in accuracy each month, but the variance analysis provides critical insight into the underlying drivers of the business and allows early identification of trends. In some instances, it may not be the model that needs to change but the process of creating the budget in the first place.

These models are not difficult to build; a treasury staff member or even an outside consultant can be charged with building, maintaining, improving, and presenting them for the benefit of the board.

Sticking relentlessly at the board level to scrutinizing the iterative improvements each month to the integrated model helps deepen understanding of the business drivers that determine earnings quality and profitability.

A More Knowledgeable Board
On the downside, it keeps visible such critical issues as compliance with key ratios and covenants and the dynamics of working capital usage. If a two-year rolling projection is employed, for example, it will help to identify possible crunch periods — tight covenant compliance or possible cash shortfalls — so they can be planned for well in advance.

A final benefit of doing this work at the board level allows shared ownership of the information itself and active knowledge in the boardroom.

Deborah Hicks Midanek is president of Solon Group Inc., a firm she started in 1989 to work with boards, management, lenders, investors, and employees of companies facing serious difficulties. She has led a variety of businesses through strategic, operating, and financial challenges. She is a frequent speaker and author on corporate governance and turnaround management issues.

This column is an excerpt from her longer article, “The Protocol of a Turnaround Manager,” published in the Second Quarter 2008 edition of Directors & Boards.

She can be contacted at dhmidanek@solongroup.com.