For many entrepreneurs, these are trying and uncertain times. Cash is critical and many companies are facing the twin fronts of attack of vendors wanting their money up front and customers delaying payments.? All the while, employees still need their regular paychecks. Therefore, if a business is experiencing a liquidity crisis, management (and their key advisors) must act quickly to assess the situation and determine the appropriate plan of action.
The first course of action is to determine whether, and on what terms, additional cash resources might be made available.? There are a number of ways a business can free up cash.? The determination of what options to pursue will depend on the specific facts and circumstances and must take into account the health of key relationships (i.e. vendors and bankers) and the general economic climate.? Below is a list of some of the options available for entrepreneurs:
- Trim the fat: Reduce overhead and cut expenses
Most businesses wisely start here because the decision to cut expenses is within the control of management and generally does not require the need to get approval from outside parties such as lenders. This cost reduction could include closing unprofitable store locations or divisions. Sound accounting and reporting makes this analysis and cost reduction process much easier.? However, from a strategic standpoint, you need to make sure the cuts are not so deep that they disrupt the business? core economic engines.
- Get stingy:? Aggressively monitor collections and trade credit (especially to new customers)
A liquidity crisis often happens in an economic slow-down (like the current one we are experiencing) when all businesses are fighting over limited cash resources.? Therefore, many customers become ?slow pay? or ?no pay? and cash receipts begin to shrink. If your business is owed money, you need to obtain it.? Even if you have to bonus your collections personnel or use an outside agency, this additional cost is worth it if it brings precious cash in the door.?? Keep in mind, however, that aggressive collections also requires a balance ? you don?t want to alienate key relationships.
- Consider your leverage: Cash out or refinance existing debt
If your company is paying above-market interest rates on debt or is carrying debt against assets with substantial equity, then you should exhaust every effort to refinance the debt to cash out equity or to lower its interest carry.? However, it would be better to keep above market debt (especially if is revolver with an additional room for draws), then to obtain a new loan with financial covenants that will ultimately restrict flexibility and further distress the company.? Also, the time required (and closing costs involved) must be considered in determining whether refinancing current debt is a feasible option.
- Go back to the drawing board:? Seek concessions from existing creditors
If new financing is not available, then existing creditors are another option to consider.?? Keep in mind that ?creditors? includes not only traditional lenders, but also includes vendors that may provide goods and/or services on short-term credit.? Therefore, among the options for resolving a liquidity crisis is to ask vendors to extend payment terms, grant discounts, or provide other forms of relief.
- Get a shot in the arm:? Obtain cash through an equity injection
There are many investors that are not afraid to look for value in the form of distressed companies.? However, the ?cost of equity? is often far greater than the cost of debt ? particularly in high-risk scenarios.?? Furthermore, these investors will usually want to protect their cash via a controlling economic and/or voting interest in the company.?? This option often does not sit well with management, particularly if the company is still in control of its founders.
Again, these are just a few of the many options available.? Some of the most successful companies were founded in recessions (e.g. Southwest, Microsoft, Genetech).? By proactively and realistically addressing the liquidity crunches in their businesses, hopefully many companies will weather the current storm and potentially even turn this downturn into an opportunity for growth.
Originally published in Pointe Innovation Magazine