National Credit Awareness and Resolution Association, Inc.

Commercial loans are typically structured to include regular financial reporting of business financial statements and tax returns, as well personal financial statements and tax returns for guarantors. Such data are regularly analyzed, and if the creditor is doing his job correctly (i.e., monitoring) it should be apparent to all stakeholders when evidence begins to emerge of financial deterioration. 

 

NCARA believes, at the end of the day, a well-prepared business cash flow pro forma statement is one of the best tools to use when negotiating a workout situation, loan modification, extension, or payment deferral. Sure, the creditors will always expect to have on file all required, appropriately prepared, financial statements and tax returns for the most recent year-end, and interim financial statements through the most recent quarter, together with any other required reporting. But special attention must be paid to your actual and expected cash flows in a potential workout situation; it’s the ability of the company to meet its estimated operational, investment, and financing activities. If you’re in deteriorating financial condition, then you will have to make material adjustments to these activities and show the creditor the availability of cash, and when he will receive loan repayments. 

 

Depending on the severity of your financial condition, you may need to prepare the cash flow statement to include amounts, by month, for the next 12 months, quarterly, semi-annually, or annually. If there’s risk of imminent failure, cash flow statements may be prepared daily as well. Cash flow statements will show the stakeholders your estimated cash position, but be sure to not show the cash position you think the banker wants or expects to see; rather, make sure you estimate precisely the numbers you are very confident you can actually produce, regardless of how bad or good that may be. If it’s bad, then so be it. That’s why it’s called a ‘workout’, meaning that there will need to be modifications to your loan documents that reflect your ability to repay. 

 

The cash flow statements can be regularly refreshed and additional modifications be made as well. Make sure you clearly understand that the cash flow statement reflects what you are comfortable with, because lenders are not all that forgiving (i.e., if you fudge and put numbers you think they expect to see there), especially when there’s a downturn. Their job is to ensure your loans are returned to an acceptable “Pass” risk grade as soon as possible, or to a $0 balance. You get the picture; there’s going to be pressure on their end, and thus on you. Doing this wrong, by overestimating your cash position, will likely result in a stressed relationship, if not worse. So, tell it like it is.

 

The pro forma cash flow statement will focus on future cash receipts (inflows) and cash disbursements or payments (outflows), from activities in operations, investing, and financing. The net cash position from these activities at the end of the period will be added to the cash at the beginning of the period for the final period cash position. You will have documented, not what the creditor expects, but your best-estimated or most accurately estimated cash position for the respective periods. Make sure it is reasonable and that, barring any unforeseen emergency, you will hit those numbers. Be detailed, as appropriate. Such activities might include:

 

Operating Activities: Include direct cash receipts from customers, and the collection of accounts receivable. Disbursements will include inventory purchases, general operating and administrative expenses, wage expenses, interest expense, and income taxes. Add the receipts, less the disbursements, to show the net cash flow available from operations.

 

Investing Activities: Include cash receipts from the sale of property and equipment, the collection of principal on Notes Receivable, or the sale of any investment securities. Disbursements will include cash paid for the purchase of property or equipment, loans made to others, and the purchasing of securities. The difference in receipts and disbursements will be your net cash flow from investments.

 

Financing Activities: Include cash receipts from any stock issuances or new borrowings, and cash disbursements from any stock repurchases, dividends or loan repayments. The difference in receipts and disbursements will be your net cash flow from financing activities.  

 

For smaller, less complex small businesses, it’s reasonable to simply prepare, say a monthly cash flow statement for each of the next 12 months (plus the 12-month total), and simply list all cash receipts (inflows) together: Cash sales/collections from accounts or notes receivable, sales proceeds from property and equipment, sale of investment securities, issuance of stock, proceeds from new borrowings, and cash from other sources. The same holds true for the cash disbursements (outflows): property and equipment purchases, investment securities purchases, inventory purchases, general operating and administrative expenses, wage expenses, interest expense, principal payments, and income taxes.

 

To recap, when timely repayment is questionable or uncertain, it’s your responsibility to demonstrate to your creditors the ability to repay the money you promised to repay – whatever that is.  A debtor-prepared pro forma cash flow statement is the central bridge between the debtor and creditor; it’s all about the cash. The pro forma cash flow statement will show the projected receipt of cash on a monthly basis, inclusive of all cash disbursements to vendors and operating costs, and debt repayment. 

 

This bridge, together with supporting financial documentation, should enable debtors to readily cross-over what can feel like a ‘grand- canyon’ between themselves and their creditors. During times of economic stress, effective repayment solutions are important to the financial well-being of all stakeholders, as the repayment of your loans are in the best interest of the creditor too. Lenders need to avoid credit losses or charge-offs, and business owners want to stay in business. 

 

There needs to be a win-win, and the debtor’s best-effort and candid inputs are critically important to the repayment process. When modifications or loans are restructured, it is imperative to repay the enhanced contractual terms on a timely basis. Refreshed financial reporting is warranted anytime there are material changes to your operations, favorable or otherwise. The level of detail (i.e., monthly or quarterly reporting) will likely depend on the level or severity of credit risk and size of the loans, and will either increase or decrease as conditions merit. 

 

The creditor will also be assigning a ‘risk or loan grade’ to your credit relationship, and you should also ask what your risk grade is – as you’ll need to learn why this is important to you – this will allow you to understand where you really sit in the eyes of the creditor. Meanwhile, it’s acceptable to revisit or make revisions to already modified repayment terms, if necessary, with refreshed financial reporting. 

 

You own this, and your candor will hopefully payoff in your favor. Again, debtors should repay their obligations in full, as this is not an exercise to see what debt you can get out of paying. Liquidation strategies are a different story. But remember that you should have the opportunity to make your case on a best-effort basis, getting to a win-win solution, including terms you propose.

 

When we talk about ‘owning this’, this is serious business. You know, or will know, the stress of  insufficient cash flow, and the toll it takes on you and your family, employees, and other stakeholders. It’s a big deal. There are way too many tax returns filed these days that have alimony and child support. And there sits a small business owner by himself, with a half defunct business, where the fun of operating such a business is long gone. Way too much attention was given to the creditors at the expense of the business, but more importantly, to the family. 

 

So, if you feel any such stress, well, hopefully you can see what is meant about ‘owning this’; you don’t need to lose your family because you want to impress the creditors, right? So, prepare a pro forma cash flow that will work for you, saves your family, and convince the creditor that’s what you’re going to do. If you don’t own this, you’re not leading the way. Fix this in your head before you go forward.