24 Jun Insight: What to Do When the Money Runs Out
The US Small Business Administration’s (“SBA”) Paycheck Protection Program (the “PPP”) funding began on April 16, 2020 and has since distributed more than $500 billion to more than 4.6 million companies.
Now, two months later, many companies have utilized most or all of their funds, leaving them without a safety net and uncertain of what to do next.
The SBA’s initial guidance dictated that recipients had to deploy the funding within eight weeks and utilize a minimum of 75% of the funds for payroll to qualify for forgiveness. While the timeframe to use the funds has now been extended to 24 weeks, this change came after many companies (relying on the initial framework) already spent most, if not all, of their funds. Payroll, rent, and utilities were effectively covered by the PPP funding, allowing many companies to generate positive cash flow during this period and increase their cash reserves and availability on lines of credit. In fact, despite the precipitous downturn created by COVID-19, many commercial bankers recently reported that a number of their customers are borrowing less and have more liquidity right now than they did at the beginning of the year.
But what to do now as the money runs out? The impact of the pandemic on businesses will vary widely based on industry and geography and, for many, the pace of the recovery and return to profitability will not come before the current liquidity cushion runs out. Businesses will fail as a result. In other cases, the need to pay down past-due suppliers and restart operations after extended shut-downs may be creating liquidity issues, even though revenue may have returned to profitable run-rates.
The excess liquidity from the PPP should provide a cushion even after the disbursement period ends, but now is the time to develop strategies to mitigate economic risk. Many businesses have been hesitant to prepare detailed plans because of the economic uncertainty, e.g., “Why bother putting together a forecast? We might as well just throw darts at a board!” While pursuing a “wait-and-see” approach is an understandable reaction, the amount of economic uncertainty we currently face is exactly why businesses should be throwing some darts, so to speak, and developing contingency plans (plural). Those who wait until the dust settles to evaluate strategy will probably be too late.
Earlier this year, we were in a position with several of our clients to proactively lay out strategic plans prior to receipt of their PPP funds, allowing them to work within the (then existing) parameters for loan forgiveness, while developing action plans to adjust and “right-size” infrastructure and operations immediately upon hitting the forgiveness requirements. This advanced planning allowed our clients to be in the best possible position for their new, post-COVID economic reality. Our recommended approach is the same whether a business just received its PPP funding or has already completed its eight-week (now extended to 24 weeks) expenditure period:
Management should first assess their current and short-term future liquidity, making sure to consider current cash on hand (net of all outstanding checks), current borrowing availability, expected receivable collections, and required disbursements. This is best accomplished through the financial industry standard “thirteen-week cash flow forecast,” which is a comprehensive, weekly cash forecast incorporating all of the previously noted variables. Multiple scenarios should be considered and, in businesses with significant seasonality, a longer outlook will probably be necessary.
Next, if liquidity appears to be an upcoming potential issue, management should immediately:
- Review expected disbursements and distinguish “want-to-pay” from “need-to-pay” items
- Be sure to include any new post-COVID costs (e.g., PPE, more frequent cleaning, increased employee compensation due to competing with unemployment compensation, etc.)
- There should be no sacred cows when considering what expenditures can be eliminated or deferred
- Assess labor mix and overall staffing levels to maximize net positive cash flow, and consider staff adjustments that can or should be made (likely implemented after the PPP expenditure period ends)
- Reconsider upcoming capital expenses
- Look for opportunities to increase and accelerate cash inflows
- Investigate sources of new capital (e.g., increase in line of credit and/or more generous formula terms, new financing arrangements, etc.)
Finally, with their short-term liquidity issues resolved, management can turn their attention to ensuring long-term financial stability by ensuring profitable, cash-flow positive operations at new, post-COVID revenue level.
- Post-COVID profit and loss forecasts should be created, with multiple scenarios considered
- Focus on how to reduce fixed costs and achieve break-even or better profitability at various revenue levels
- Consider selling underutilized equipment/facilities, and renegotiating and/or rejecting unprofitable revenue streams
- Consider any possible opportunities to generate new revenue (e.g., craft breweries making hand sanitizer)
- Review vendor relationships
- Maintain good communication with vendors, especially if payables are being stretched
- Management should pay close attention to the financial condition of its key vendors, since their financial problems can quickly become your problems
Throughout the process, it is important to ensure a stable relationship with lenders. This is especially important in the current environment where lending standards are getting tighter, pricing is increasing, and collateral valuations for machinery and equipment and real estate are under pressure.
- Management should reach out to their lender(s) proactively, especially when loan modifications may be needed. Bankers tend to assume the worst in the absence of good communication and current information, so keeping them informed is key.
- Present a comprehensive, realistic plan with well thought out, documented assumptions
- Be prepared to offer accommodations to the lender (e.g., providing additional collateral or personal guarantees in exchange for lender accommodations). Lenders will typically not respond well to a plan where they are being asked to carry the bulk of the financial risk.
The most important take-away we can leave you with is that the sooner you begin planning, the better. Revisions to strategy are inevitable but are much more easily managed than trying to develop a strategy after a crisis has arisen. Businesses need to manage day-to-day operations, stay on top of the changing economic and regulatory conditions, and manage customers, vendors, lenders and employees – a challenge even during the best economic times.
You are not in this alone, though. Everyone is trying to weather the same storm to a greater or lesser extent, and we can take heart from past experiences that promise that this, too, shall eventually pass. In the meantime, please don’t hesitate to reach out to any of Amherst’s professionals to discuss questions you may have on this article, or any other matters for which you may require assistance.