When your company is falling behind on its creditors, you need a cash flow projection that helps you prioritize and justify a reduction or deferral of what you owe. For a settlement plan, that pro forma is the 13-week cash flow model, a cash flow forecast that is widely used when working with lenders and other creditors to restructure a business.
So what is it, exactly? A 13-week cash flow model is an internal analysis, built week by week, that looks only at cash - cash inflows, cash outflows and net cash flow - that covers the next 13 weeks and analyzes how cash will be affected by key business activities. It is useful for your company internally and for what you need to prove to your creditors as the basis for a proposal to reduce or defer payments.
When you are in financial distress and are behind on payments to one or more creditors, you are going to need to prove why you cannot pay. If you have ever been in this situation, you know that it is not enough to simply say you need a break. While the most common use is for bankrupt companies, any business that owes more money than it can pay should prepare a 13-week cash flow model. The 13-week cash flow statement is also really useful for a company that is not in a bankruptcy situation, including one trying to calm a lender worried about a liquidity squeeze or broken covenants. Cash is King. It sounds cliché, but in a time of financial distress it is undeniably true.
Your lenders, any new lender, a possible buyer, your other creditors and, in bankruptcy, the court will all read it for two things: where the problems are, and where the cash is that could support a restructuring. A 13-week cash flow model proves that you have really done your homework.
A Cash Flow Projection Starts with Cash
Unfortunately for those of us who were not trained in finance, many laymen do not completely understand the difference between a profit and loss statement (often called a P&L or income statement) and a cash flow projection. The profit and loss statement is usually based on accrual accounting, meaning that your revenues are realized when the goods and services are delivered to your customer and your expenses are calculated when they are incurred. Net income does not always translate into cash on hand. Rather than net income, a cash flow projection starts with cash. The 13-week model uses the direct method instead, which boils every activity of the business down to the amount of cash that you received and the cash you paid. The only question is: When will the cash come in? When will it go out? If it didn’t come in, then it didn’t happen. If it didn’t go out, then it didn’t happen.
The forecast has two sections, operating and non-operating. In the operating section, on the receipts side, you list the cash - and only the cash - that your company will receive from customers for its sales or services. On the payments side, you want to show how much you actually paid for expenses of every kind: merchandise, raw materials, wages, insurance, rent and taxes, plus capital spending, as long as it is operating in nature. The non-operating section analyzes the impact of transactions and events that are not “core” to your business, mainly financing. By this stage most spending has usually been cut to the minimum, but a few items show up here again and again, chiefly the fees you pay to manage the problem: the legal and advisory fees for your turnaround. The rest are costs associated with the maintenance or repayment of debt, like interest payments, lender fees and the like. When preparing it, stay as close to cash as you can.
Converting from Accrual to Cash
So how do you build it? Start by pulling together your general ledger, balance sheets, P&Ls and cash flow statements. A 13-week forecast covers a quarter, so get all of that data. Then comes converting from accrual to cash. The idea is simple - list only cash inflows and outflows - but the execution isn’t. You reconcile the cash account for changes in your balance sheet accounts and turn the income statement into cash, which in practice means answering three questions.
- How much money, exactly, will you collect on accounts receivable each week?
- How much will it cost to make the products you sell?
- How much will you pay out in payroll?
For collections, you take the beginning account receivables plus all sales in the 13-week period, then subtract what the accounts will be worth at the end. For the cost of goods, you start with the inventory balance at the beginning of the forecast period, bring in the ending inventory and the cost of goods sold, and solve for what you actually spent on purchases. Wages work the same way: beginning wages payable, plus wage expense, minus ending wages payable. What is left is what you have actually paid. Remember that your wage expense is always expressed on an accrual basis - based on when the work was done and not the time wages were paid. Then fill in the other operating disbursements (insurance, rent, taxes, capital spending, prepaid and accrued expenses) and the non-operating interest and fees.
Net Cash Flow
The number at the bottom of each week, the net cash flow, is what the whole exercise is for. It tells you if your business actually makes or spends cash, and the week by week view shows you where it really does. The 13-week cash flow forecast tells you how much money you have on hand, how much it will cost to operate your company and the impact of your bills on the company. It shows whether you need financing, whether any is available, and whether the business can add debt or it needs to reduce or defer the debt it already has.
A 13-Week Cash Flow Forecast provides much more than a detailed cash analysis. It also forces a business to examine its expenses, inventory and assets. It isolates what is behind weak receipts or rising cash burn, and shows you what to fix and how much cash it will take to fix it: costs to cut, inventory to liquidate, assets to sell. It points to the changes that will make the most difference, both in your business and in the proposal you make to your creditors. Whatever it is, each action needs an impact on cash flow, and you calculate that impact by looking at your 13-week cash flow model. Just remember, the answer is always in the cash.
With all that behind you, a 13-week cash flow model is the perfect document to show your creditors as the basis of your request for relief. The conversion from accrual to cash is the key to proving that your proposal is more than just a desperate plea. When you bring the numbers in from the P&L and balance sheet, you are using real numbers, the same numbers you are using to run your business.
