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Don’t Let Cash Burn Catch You by Surprise

A financial statement tells businesses where they’ve been, but it’s the cash burn rate that signals where they’re headed.

For Drew McManigle, too many companies fail to keep tabs on this all-important bellwether of corporate well-being.

“The financials don’t run the business,” said McManigle, founder and CEO of restructuring firm Macco Restructuring Group. However, companies “need a true 13-week, 26-week and 52-week cash flow statement that tells you how much cash you’re going to have and if—and when— you [will] run out,” he added.

While a cash flow statement is a simple spreadsheet showing the sources of cash coming in at any given time, figuring out the cash burn rate requires companies to drill down deeper. The math is straightforward: subtract the costs flowing out from the revenue trickling in. Ideally, a company should have something left over each week. The cash burn rate is the “amount of cash that you’re burning over and above” the revenue minus all the costs. But even that isn’t enough to figure out if a business is bringing in enough cash for day-to-day operations.

According to McManigle, businesses go through different cycles. In retail, for example, stocking up on holiday inventory would drive a temporarily high cash burn. That’s why he suggests the 13-, 26- and 52-week reports so business executives can get an early warning that something is out of whack.

“That allows you to analyze and look at [the business] from the standpoint of ‘When am I going to be running into some type of trouble?'” he said, adding that companies often generate high sales without realizing they have a negative burn rate and are actually cash poor. And by the time they realize it, the liquidity problem often snowballs to the point where bankruptcy seems more likely than not.

Companies facing a negative cash burn rate should act quickly to reduce costs. While that may mean laying off staff, it also could mean stretching  payable terms by 30 days and negotiating vendor agreements.

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What else does McManigle recommend?

“The first thing is to look at how much trouble you’re in, what’s the cash burn, why did you get there, and what steps can you take to resolve the issue,” McManigle said.

He also said management needs to a look at where the company is versus competitors. That plus the cash burn rate and viability of the company’s strategic plan could give management a “pretty good picture of what’s going on and what it needs to address first.”

McManigle said cash burn ignorance is so common that “we almost always get called too late because the company or folks think they have a handle on it, and then they find themselves in deeper trouble.”

That means many companies find themselves with few options besides Chapter 11. When that happens, businesses should evaluate and prioritize “critical vendors” and determine how bankruptcy could affect supply chain partners even if they secure debtor-in-possession (DIP) financing to keep the doors open during a court-supervised reorg.

“If you owe a Chinese vendor $5 million, and it supplies 20 percent or 25 percent of your goods, maybe they don’t want to do business with you anymore,” McManigle said. “That’s a big problem, so you’re going to have to think through the alternatives.”

Because Chapter 11 has gotten so expensive, companies should consider non-bankruptcy alternatives such as setting up a receivership, which is a strategy overseen by the court that helps creditors get their hands on the money they’re owed by a firm that’s defaulted on loans.

Stable credit markets mean DIP financing is available for companies that need it, even if it’s getting more expensive. For smaller firms relying on personal owners to put up a guarantee, “lenders are taking a harder look at individual credit, so that’s becoming a little more difficult,” McManigle pointed out.

He expects an uptick in bankruptcy filings, most of which are likely attempt to restructure finances instead of addressing operational failures. Some companies opt for a pre-packaged plan in their court-approved bankruptcy exit. They tend to have a higher risk of becoming the dreaded so-called Chapter 22s who end up back into bankruptcy court for a second Chapter 11.

McManigle also advises companies doing a balance-sheet restructuring to also take a hard look at operations and the existing business model. It’s one way to avoid a repeat of what got companies into dire financial straits in the first place.

“You can play with the balance sheet and you can move the debt down and stretch that out, but if your basic business model is not being addressed—if someone doesn’t want to buy your khaki pants anymore—I can model the balance sheet all day long but it’s not going to make any difference. Somewhere along the road of restructuring, someone has got to take a look at the business model and say: What are we selling? Who are we selling to? What’s working? What’s not?” he said.