The financial model is the most important tool in the turnaround and financing of a troubled company. Throwing more money at a troubled situation without a distinct plan of action is not the solution. Financial models create a detailed outline of the use of funds and instill trust in the lender that the management team understands the strategy, can execute and is committed to regularly evaluating their performance. We build at least two models, a monthly model and a 13-week cash flow.
The monthly model includes three financial statements: balance sheet, income statement/profit & loss (P&L) and cash flow. We start with the income statement and work from revenue to net income, breaking out each of the revenue sources and costs line by line. As operators, we build a model that can be updated to actual monthly results. This way we can asses the company’s results against the projection on key performance indicators and discuss effectiveness, if we need to adjust the outlook and how this will impact cash demands.
The balance sheet line items are largely driven by the assumptions made about components of P&L: AR collection and AP payment terms, prepayment, depreciation, so on.
A monthly cash flow is best prepared as a derivative of monthly projected balance sheets and income statements. It is really a Statement of Changes in Financial Position calculation. Using this approach makes the cash flow dynamic to sensitive cash drivers, like working capital assumptions, and will automatically flow through the model and provide insight on the direction of cash balances into the future. It also acts to reconcile the cash flow with the balance sheet and P&L.
Monthly cash flows are required because turnaround plans, repayment of debts and business valuations require a longer horizon than is offered by a 13-week cash flow. The model can range from months to years, depending on the plan length.
A 13-week rolling cash flow model presents receipts and fixed and variable disbursements of the company, by category, by week. This format is invaluable for decision making as it allows for a quick scan across a three-month period to understand where negotiation of payment terms may be effective. It is the primary tool required by lenders to these companies and should accompany all existing and prospective lender presentations.
Financial models are not standalone documents that are included as part of a funding package. Companies often have outdated models that do not tie into the strategic plan being presented to lenders and investors or show a projected decline of profits and cash flows. These models useless and do nothing to create trust with lenders and move the company forward to profitability.
No restructuring scenario goes exactly as planned and experienced lenders expect this. However, they also expect the management team to recognize these hurdles and have a plan to overcome them.
Models are tools of a larger plan that should be regularly updated and reviewed. They are an opportunity to reflect on quantitative results and share them with investors and lenders.
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