Funding A Business Turnaround 2 Three Critical Questions

The initial and urgent question at the outset in any a cash crisis is whether the business meets an insolvency definition since if it does, it may need insolvency help.

Is The Company Insolvent?

In principle, insolvency simply means that the company is unable to pay its debts as they fall due. The Insolvency Act (1986) sets out four tests, failure of any of which is taken to prove insolvency where a winding up is sought on these ground:

• failure to deal with a statutory demand;

• failure to pay a judgement debt;

• the court is satisfied that the company is failing to pay its debts where due (the cashflow test);

• the court is satisfied that the company's liabilities (including contingent and prospective ones) are greater than its assets (the balance sheet test).

Insolvency is important because if the company fails, a liquidator can potentially:

• act to set aside some transactions made when the company was insolvent; and

• hold you personally liable for the company's losses.

Additionally, your responsibility for the insolvency will be taken into account when considering company director disqualification proceedings.

If you are not trading through a company but are acting as a sole trader however, you have unlimited liability for all your own debts (business and personal). If you are trading in a partnership, all the partners are liable together and individually for the partnership's business liabilities (jointly and severally).

The moral is, when in doubt, if you are concerned about solvency, you should seek professional advice concerning your balance sheet position and your short and medium term cashflows. This advice may then enable you to legitimately continue to trade your way through while meeting your legal responsibilities.

Do You Have Sufficient Cash For The Immediate Foreseeable Future?

To answer this you need a cash flow forecast. At this stage you usually need to concentrate on the short-term and prepare a forecast on a weekly basis for the next 13 weeks, but in extreme cases you may need to prepare one on a daily basis, covering only the next few weeks.

The cash flow forecast will be a vital document, for:

• actively managing the cash to ensure survival;

• obtaining proper advice as to whether to continue to trade (to protect your personal position); and

• obtaining and maintaining lender support.

Cash flow forecasting is essentially straightforward as you are dealing with real cash movements into and out of your business, not more abstract accounting transactions, such as accruals, prepayments or depreciation.

For a weekly forecast, all you are looking to calculate is:

• the cash you are going to get in that week

• less the cash you are going to pay out that week

• to give a net movement (flow) of cash into or out of the company.

Adding the net inflow (or deducting the net outflow) of cash to the balance held at the start of the week gives the balance at the end of the week to be carried forward to the next.

When preparing a cash flow forecast:

• Be realistic in your estimates of timings and amounts of cash and when in doubt, be prudent. Be pessimistic about when and how much when you are going to have to pay money out and when people are going to pay you.

• Make your assumptions explicit. If for example your forecast assumes sales are going to increase substantially due to a new contract coming on stream then you should say so. Otherwise lenders who may be looking at the figures may just think that you are relying on the new sales fairy to wave a wand and make this happen.

• Experiment with sensitivities by flexing some of your key assumptions (what if sales go up by 5% instead of 10%, what if customers take 60 days to pay instead of 45?) to see how sensitive the forecast is to these fluctuations.

• Think widely. Check that you have allowed for all possible payments that may need to be made. Have you allowed for any unusual or one off payments such as corporation tax, redundancy payments, pension top ups, capital expenditure or repairs if any of these are likely to fall due in the period? Turnarounds tend to require professional assistance. Have you allowed sufficient to cover the accountants', lawyers' and bankers' fees?

• Finally, remember that you do not have a 100% reliable crystal ball. Build in a margin as a round sum contingency to allow for the things that will inevitably come crawling out of the woodwork. The more uncertain your starting point, the larger this needs to be, up to say, 10% or 20% of payments in some cases. Part of the reason for cashflow forecasting is to build your lender's confidence that you are in control of your finances. Having a contingency in place is not only prudent, but if it helps to ensure that you beat your forecast cash performance, it will also help to ensure that your lender's confidence in your management skills will increase.

Will Your Lenders Continue to Support You?

The good news is that lenders will tend to support customers in difficulties where:

• the lender trusts your integrity;

• you talk to them in time (and seem likely to continue to talk to them);

• you seem to be in control of your business (and its numbers);

• you have a plan;

• the plan sets out clearly what support you need (how much, how long, how it is to be paid back);

• you are prepared to get in help where you need it;

• the lender is confident your plan can work;

• the lender is confident you can make it happen; and

• your plan does not materially increase the lender's risk.

This last point is concerned with the current level of the lender's security which will be covered in the next article.