13-Week Cash Flow Model
Creates Clear Communication Channels

(TMA International Headquarters)

The ability to forecast, monitor, and perform in the short term can establish the foundation for a consensual and beneficial outcome for interested parties in a well-run turnaround or restructuring engagement. The short-term forecast preferred by practitioners, lenders, creditors, and most other constituents is the 13-week cash flow (TWCF) model.

A group of practitioners whose specialties include interim and crisis management, debt restructuring, and raising capital recently participated in a roundtable discussion on the topic moderated by this month’s guest editor, Ron Reuter. Participants included:

• Ray Anderson , the founder of Burnham Venture Management.
• Frank R. Mack, CTP , a managing director with Conway MacKenzie & Dunleavy.
• Anu R. Singh, CTP, vice president with Kaufman Hall.

Why is the TWCF the industry standard?

Anderson: Whether inside of a bankruptcy or in early decline, all of the constituents need to focus on the short-term liquidity requirements of the company while also examining medium-term trends that signal the potential need for additional funding. Thirteen weeks seems to be the right amount of time to meet all of these requirements. Additionally, thirteen weeks is not so far out that the forecasting is speculative.

What are some of the factors that make it so appealing?

Mack: The appeal to both the company and its parties in interest is that the TWCF model communicates the quantified operating and strategic plans for a company based on its defined exit plan, such as restructuring, recapitalization, going-concern sale, or orderly liquidation. Over the duration of a TWCF model, the underlying operating plan should maximize the net cash flows and enterprise value of the company within its constraints.

Ancillary quantitative models, such as accrual-based financial statements, pro forma reports and forecasts, and liquidation and waterfall analyses, are all derivatives of the TWCF model. Therefore, the TWCF model not only serves as the company’s overall business and strategic plan, but also accommodates an understanding of the financial impacts of the TWCF to the respective recovery and/or transactional strategies of the company’s parties in interest. Thus, the TWCF model is the accepted industry standard in all corporate renewal situations because of its practical applicability to its users and its effectiveness as a communication tool.

Singh: Even beyond its purpose, the structure and the methodology underlying a TWCF model is what makes it so appealing. First, no accounting accruals or management judgment regarding how balances should be calculated is considered. The triggers are simple—when will cash come in, and what is the order in which obligations must be addressed?

Second, it provides visibility. Consider cost of goods sold from the income statement. How much does it really tell you about direct materials, direct labor, and selling expenses as individual components? Not much. A TWCF model allows the reader to see otherwise aggregated data to be decomposed. Finally, due in part to the first two factors, it becomes the best manner in which to track the turnaround efforts of a company.

In what ways can the TWCF model guide a distressed company?

Anderson: A properly prepared TWCF should provide a company and all of the constituents with a roadmap to the ultimate exit. A TWCF illustrates a company’s cash sources and uses, and any operational shortfall must be provided for through the anticipated date for the exit—either through a Section 363 sale, confirmation of plan of reorganization, or other event.

If the TWCF reveals a significant shortfall that cannot be filled, the company must reexamine the business plan or preferred exit strategy. It is also critical to look beyond the TWCF in analyzing a company’s actual performance compared to the plan. For example, a company could stretch its payables, which would create an unrealistic picture of cash utilization and mask the true economics of the business performance.

Mack: Senior management and the chief restructuring officer (CRO) ultimately are responsible for the approving and executing an ambitious TWCF model within the company’s financial constraints. However, the underlying balanced operating strategies driving the model should be created by the functional managers responsible for executing the sales forecast; engineering, purchasing, production, and distribution schedules; and cash conversion cycle elements of the TWCFM.

Ownership of operating strategies should reside with the company’s functional managers. Actual-to-budget comparisons by functional areas should be performed no less than weekly, and variance analyses should be used to create and implement key corrective plans for the revised TWCF model. It’s a form of Deming’s concept of continuous improvement applied to the operating elements of TWCF models.

Timelines, operating goals, and variances should be shown to line employees so that they are aware of performance expectations. These concepts and processes often are utilized by the best run multinational companies and are essential to underperforming companies to maximize performance and enterprise value.

How does the TWCF relate to the stages of a turnaround?

Singh: Most turnarounds include a five-stage process: change in management, evaluation, critical actions, stabilization, and an eventual return to normal. A TWCF, when introduced early enough in a case, focuses management on changing how it runs its business. More specifically, it can disarm a long-term, sales-focused orientation and concentrate management on short-term cash flow.

That singular change often leads to an assessment of what factors are limiting the cash flows of the business, whether they are the poor collection of receivables, ineffective vendor strategies, or a high fixed-cost burden, all of which might have been buried in other types of financial forecasts. With this awareness, turnaround steps can be implemented and tracked weekly.

Once a turnaround is progressing, the tracking generally results in lower variances and fewer surprises. At this point a distressed firm can look to the other steps required to engineer a return to normal.

How do you convince parties—management, lenders, and creditors—of its importance?

Anderson: For creditors or other providers of capital, the company’s TWCF should be a critical element of the credit or investment process. It sets the parameters under which funding will occur and should be monitored closely to determine whether the expected returns will be realized.

A buyer may not have access to management’s TWCF. However, potential buyers should construct something like the TWCF, including short-term changes to the business plan, as part of an overall plan to recapitalize a company and ultimately return to growth. Without a TWCF at the inception of the acquisition, an acquirer cannot be certain of the short- to medium-term capital needs of the business.

Mack: I believe a comprehensive TWCF that is ambitious, yet within the realistic financial and operational constraints of the company, is self-convincing. The velocity of the company’s turnaround initiatives and the predictability of its overall performance against the TWCF are key to acceptance by parties in interest and stakeholders.

If the company’s negative surprises are continuously outside of the expectations of its relevant parties in interest, they will pursue adversarial strategies that minimize their respective risks and maximize their respective recoveries. This is especially true with respect to key customers, senior secured and subordinate lenders, and critical vendors.

When potential buyers and/or alternative lenders are underwriting transactions based on a company’s TWCF, the company’s negative variances usually result in unfavorable changes to the terms, conditions, and pricing of these transactions and in certain circumstances will cause them to be terminated. Given the complexities of business and capital structures typical to this segment of the economic cycle, it’s critical for a company’s business and strategic plans, as quantified by the TWCF, to be both accepted by parties in interest and stakeholders and consistently executed by the company.

Have you used the TWCF as a means to earn back credibility with constituents? How?

Anderson: Whether a company has filed for bankruptcy or violated loan covenants, it has lost credibility with its lenders. If a company can prepare an accurate TWCF and meet its targets, it will recover a degree of credibility with its lenders.

Singh: I have been involved in cases in which it was the only way to restore credibility. It is significantly easier to build and eventually share a TWCF model based on facts and reasonable assumptions that indicates what is needed to fund a turnaround than it is merely to ask for forbearance or another form of accommodation from your bank.

Too many management teams initially want to disclose less information and make it easy to blame their woes on the fact that the bank has not provided the cash they need. If the same effort is put forth in demonstrating the cash position and forecast of the company, most reasonable banks will listen. That is where the recovery of credibility often begins.

How else has the TWCF assisted you in difficult communication situations?

Anderson: Often the TWCF provides a dose of reality to management teams that are in denial. In accrual accounting, a company may be able to mask some of the difficult challenges it faces. An example of this would be an inventory build without a concurrent increase in revenues.

The TWCF is an illustrative document that removes some of the obfuscation that can be a part of accrual accounting. It should illustrate the weaknesses in the company’s business plan over the short to medium term from a cash-flow standpoint. This is often useful in demonstrating to management the flaws in its business plan that may not be as apparent when viewed on an accrual basis. In the case of the inventory build, for example, the TWCF would illustrate cash being used to purchase inventory without contemporaneous cash inflows.

Can the TWCF impact the speed and success of a turnaround?

Anderson: An accurate TWCF is integral to building credibility and trust between management and lenders in a turnaround. Trust between management and a lender is critical in navigating the twists and turns of a turnaround. Therefore, management that consistently meets its TWCF goals will have an advantage in completing a turnaround in a timely and effective manner. Conversely, a management team that consistently misses its TWCF goals will find that lenders become skeptical of the company’s plan and less cooperative during the process.

Singh: Even internally, the same concept can provide significant dividends for a company. When company management teams are aware of the turnaround steps taken and can relate the impact of each effort directly to the balance and trajectory of cash flow, the pace and intensity of corrective actions are catalyzed. A TWCF can be much more than a spreadsheet that you send to your bank every Tuesday. It can be the best scorecard a company has to monitor its progress and accelerate recovery.

What are the best practices of a TWCF model?

Singh: It’s a very tough question, but a few critical components should exist. First, the model should touch all important facets of the business. The shipping and receiving manager may know much more about special customer treatment involving shipments or even returns than does the executive team, for example.

Second, the model must be dynamic. The first few weeks may be well off the mark. It is important to track variances to determine where the model works and where it needs more work.

Third, it should have documentation, a mini owner’s manual. Key assumptions and methodologies should be documented. Sources of support for balances should be provided. Changes from previous versions should be articulated.

_________________________________________________________

Ray Anderson; Frank R. Mack, CTP; and Anu Singh, CTP, serve as the Continuing Education Committee for TMA’s Chicago/Midwest Chapter and developed the 13-Week Cash Flow Workshop. The first workshop was held by the Chicago/Midwest Chapter in May and was made possible through a grant from Cornerstone 15. The workshop, which expands on the Troubled Loan Workout program, will soon be available to other chapters.