We all want to return to normal, or the new normal, as quickly as possible. The question businesses and their stakeholders need to ask themselves is what does normal mean and how can the return be financed?
For most companies, their working capital has been depleted during the shut down as they struggled to pay employees and keep vendors satisfied, while dealing with impacts to sales and accounts receivable.
The staged return to normal, as defined on April 20, is summarized as follows:
Phase 1:
Vulnerable individuals shelter in place.
Maximize physical distance when in public and no gathering of more than 10 people.
Minimize non-essential travel and adhere to isolation following travel.
Telework is desirable. Return to work in phases. Close common areas.
Schools, camps, daycare, etc. remain closed.
Visits to senior living facilities and hospitals are prohibited.
Sit down restaurants, movie theaters, sporting venues, places of worship can operate with strict physical distancing.
Elective surgeries can resume at outpatient facilities.
Gyms can open with physical distancing.
Bars remain closed.
Phase 2:
Vulnerable individuals shelter in place.
Maximize physical distance when in public and no gathering of more than 50 people.
Non-essential travel can resume.
Telework is encouraged. Close common areas.
Schools, camps, daycare, etc. may reopen.
Visits to senior living facilities and hospitals are prohibited.
Sit down restaurants, movie theaters, sporting venues, places of worship can operate with moderate physical distancing.
Elective surgeries can occur at outpatient and inpatient facilities.
Gyms can open with physical distancing.
Bars may open with diminished standing room occupancy.
Phase 3:
Vulnerable individuals may resume public interactions but should practice social distancing and minimize social interactions.
Low risk populations should minimize time spent in crowds.
Unrestricted staffing for employees.
Visits to senior living facilities and hospitals are allowed however diligent hygiene is requested.
Sit down restaurants, movie theaters, sporting venues, places of worship can operate with limited physical distancing protocols.
Gyms may be open but must adhere to standard sanitation protocols.
Bars may increase standing room occupancy where applicable.
Vulnerable individuals are considered the elderly and those with underlying conditions identified as high blood pressure, chronic lung disease, diabetes, obesity, asthma, and those with weakened immune systems.
That was interesting but what does it mean?
First, it means there will be long term impacts to businesses across the economy.
Second, it means there will be varying impacts based on the industry, the geographic location in which the company operates and the geographic location where it serves its customers, and the health of the employee base.
Third, it means the transition to the new normal will be extended, and may be delayed based on the way the virus acts.
What happens to working capital?
Beginning in February, businesses felt the impact of the virus in many differing ways. But, across the board several things happened:
Accounts receivable collections slowed.
Inventory was either depleted or could not be sold.
Accounts payable were stretched.
The level of these working capital changes were offset in part by reduced expenses and in part by disaster loans, the CARES Act (PPP loan and deferred employer payroll taxes), and debt restructuring or payment deferrals.
Assuming the business makes it through the immediate impact of the virus, there will be ongoing issues with working capital. Many businesses used their working capital to fund operations and will not be able to generate levels of working capital needed to return to normal operating cycles.
First let’s look at the working capital and operating cycle of a sample company pre shut down, during shutdown, and under two different staged reopening situations.
During the shut down the company’s accounts receivable stretched out – companies were conserving cash. The inventory probably increased but in categories that could not be readily sold or inventory levels severely reduced, either of which results in the company needing to purchase inventory to restart. Most companies used their payables to finance their cash needs. Companies may have the benefit of a PPP loan and used that to fund employees, rent and utilities during the shut down.
In the first example of a staged reopening, the AR turnover was able to reduce from 70 to 50 days, well on the way to normal of 35 days, the inventory turnover decreased from 60 days to 50 days, and the AP turnover had to return to 30 days to ensure a good flow of product.
In the second example of a staged reopening, it takes the company longer to return its AR and inventory terms to closer to normal, but the AP turnover still had to return to 30 days to ensure supply.
During normal operations the Company’s operating cycle was 55 days. During the shut down the operating cycle increased to 80 days. The two staged reopening situations arrived at an operating cycle of 70 days or 85 days.
Using a return to the pre shut down revenue run rate means the first staged reopening situation will need $3.5 million, compared to estimated availability under a line of credit of $3.1 million. The company will have a $375,000 shortfall of cash to fund its operations.
In the second staged reopening situation, the company will need $4.2 million compared to availability of $3.6 million. The company will have a $625,000 shortfall of cash.
The PPP loan proceeds were required to fund payroll, rent and utilities and did not result in a paydown on the line of credit.
What does this mean?
Companies will be looking to their owners and their lenders to fund this shortfall. Lenders will be confronted with a wave of requests for overadvances or reduction in reserves. Owners will be asked to fund shortfalls.
The operating cycle and working capital impact of the reopening is going to be somewhat lumpy and erratic. But, a company needs to plan and forecast that transition back to normal.
The level of uncertainty is not an excuse to reduce reliance on forecasting but, rather, a reason weekly cash flow and borrowing base forecasting is even more critical than before.
We are ready!
Focus Management Group understands uncertainty and is able to help companies and their lenders plan now for the next phase.