Vol 4 (2007) - Issue 4

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Developing a Cash Culture

With debt levels rising by the year, there is an urgent need for highly leveraged companies to manage their cash more effectively to avoid falling into distress. By building a cash culture, management can start to get working capital under control and win the confidence of banks and the capital markets.
In the past four years debt levels have climbed inexorably upwards, with average ratios for new leveraged buy-outs standing at 5.4 times by the end of 2006
– up from 4.0 in 2002. Indeed, 2006 was definitely a borrower’s market with new high yield bond issues reaching close to USD 200 billion (a 50% rise) and leveraged loan volume going up even more, by 65% to USD 500 billion for the year.

With so many businesses borrowing beyond their comfort zone, many have only staved off financial problems by turning to low cost capital, even in some cases undergoing multiple refinancings within a relatively short time period. Surprisingly, these debt levels have not yet led to the expected high rate of distress, with defaults at an all-time low of 1% by the fourth quarter of 2006, although some commentators feel that this situation cannot hold for too much longer.

In order to keep their heads above water, many com-panies are now having to adapt to a new set of rules. Where once the focus was primarily on profitability, there is now more and more attention being paid to cash. The new stakeholders in leveraged businesses naturally want a return on their investment and are trying to squeeze out as much cash as they can, and this, combined with large interest repayments, has put intense pressure on management.
It will not necessarily take much to tip a company into default: a poor sales quarter; further oil and gas price rises; continued decrease in the value of the US dollar. To avoid falling over the edge, managers should seek to return to the first principles of sound cash management.

Back to basics

When a business has any kind of cash crisis, the refinancing terms tend to be very restrictive, with banks keeping a close watch on any shortfalls in cash generation that could quickly lead to a breach of the repayment terms. And with investors, banks and other stakeholders putting pressure on the company to gen-erate more cash internally, CEOs and CFOs are having to get back to basics and start thinking about how to manage the business more around cash and ingrain a cash culture within the organisation. To achieve this they have to approach the following three areas:

Forecasting

Accurate forecasts of cash and working capital levels can help to give management a clearer view of the com-pany’s position and assure lenders that the business is well run. Forecasting can help highlight potential problem periods that may lie ahead and even identify specific customers that may need particular attention. Accurate forecasting is the first step on the road to ef-fective cash management, and any lender will want to see evidence that this practice is an integral part of the company’s operations.