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Step 4 in Avoiding Bankruptcy – Install an Early Warning System

Furthering this series of how owners and executives can take action to avoid bankruptcy, I am going to outline the fourth step in The KGI System™Install an Early Warning System Related to the Financials to Avoid Surprises with Creditors.

Most executives have been trained to manage the profit and loss statements. They are usually familiar with such concepts as profit center reporting, responsibility center reporting, flexible and static budgets, and standard cost control. In the back of their Management Reporting Package, there was most likely some limited balance sheet and funds flow data that went virtually ignored. After all, “If the earnings are there, if the predicted earnings per share are achieved, we are in good shape, right?” Wrong! That balance sheet that you always wanted to know about but were afraid to ask will now become your “bible”. You will learn to study every element so that funds can be made available when needed to keep the company alive. The profit & loss statement becomes useless in many turnaround situations. In fact, it will sometimes be necessary to sacrifice profits in order to maximize the short-term use of funds. Executives, faced with this new set of decision-making rules, will often panic because they are traveling on uncharted waters, operating in an environment for which they have little experience and training.

Top management will need an early warning system to get through the crisis. A day in a troubled organization is like a month in a healthy company. Not only must decisions be made more rapidly but prompt reporting must be provided to ensure the executive that each decision is producing the desired result.

The exact format of the reporting system will vary with each company, but there are some basics that apply to most situations.

Basic Information

  • Weekly cash meeting and daily cash control against plan

  • A monthly planning package

All the above is utilized in addition to the overall corporate plans, which provide monthly balance sheet, profit and loss, and cash-flow information.

The focal point in a crisis environment is the weekly cash meeting. It should be run by the CFO and include all executives who are responsible for cash receipts and disbursements. These executives should come to the meeting prepared. For example, if they are responsible for disbursements, they should know the priorities of the cash requirements in their department so that they can operate effectively in a particular week in accordance with the adequacy of the cash flow. If they are responsible for receipts, they should separate expected cash inflow by level of probability. Planning of disbursements should not be based on any “blue sky” assumptions about receipts. No excuse for absence should be acceptable; everyone invited must attend and be prepared. Such meetings should be held on Monday morning to ensure that all key personnel are pointed in the right direction. The meeting should begin with a review of the previous week’s actual performance in comparison to the plan. The status of projects undertaken in previous meetings should be reviewed by the responsible executives. The controller should prepare a preliminary cash plan based on meetings held with key people separately on Friday.

Weekly Cash Flow Meeting

This weekly cycle of planning the coming week’s cash flow after reviewing the performance of the previous week is essential to good cash management. All executives whose daily decisions affect cash must be involved in this weekly process. The weekly cash plan should be available 15 to 20 weeks into the future and should be updated weekly on a sliding basis. Particular emphasis should be given to the source, timing, and amounts of major receipts and disbursements.

The idea is to have a brief, organized meeting at the start of the week and then let everyone leave with a clear set of marching orders. It is important that certain rules be observed in the management of cash in a crisis.

Some of the basic information should include:

  • Centralize responsibility under one person.

  • Centralize check signing wherever possible.

  • In a multi-location operation, each location should accumulate the checks to be paid each day, then contact the corporate office for approval. Checks that are not critical should be paid out of the corporate office.

  • The sum of all checks paid cannot exceed the daily receipts of the previous day. Top-level approval is required to violate this rule.

  • A procedure should be arranged with the company’s bank to deal with disbursements that must be made in excess of receipts. This can be accomplished through some form of short-term loan arrangement. Under any conditions, never surprise the bank.

  • Disbursements should be made as late as possible without hampering the company’s ability to run its business. When the cash-flow problem is severe, it is rarely worthwhile to take the discount and pay early.

  • All bank accounts must be authorized by the chief executive officer. All checks in excess of $X should require at least two signatures. If at all possible, big-dollar checks should be signed by corporate.

  • The basic internal controls related to cash receipts and disbursements should be followed precisely. This includes control over mail receipts, over-the-counter currency, delinquent accounts, evidence required for payment of checks, and storage of unused checks. The underlying concept of internal control is to segregate work responsibility so that no one person can use the funds of the company improperly without collusion.

I emphasize these rules because the top executive must take personal responsibility in this area. Often, when the top executive is a marketing, sales, production, or engineering type, the executive will say, “I don’t know anything about finance. That’s the job of my financial officer.” My answer is simple: “Start learning now!!” The buck stops here with the top executive! The chief executive must know where each dollar is coming from and how it is going to be spent. Check signing should be in the hands of as few people as possible. The bank must be in the role of a working partner and must, therefore, be kept fully informed.

At this stage, good internal controls become more important than ever. When a company is in turmoil, it becomes a tempting target for those people who might want to misappropriate cash for their own benefit.

Monthly Planning Package

The monthly reporting package should go to all key executives for their review and should be prepared before the tenth day of each month. It is not necessary, in my opinion, to meet and review the package. If a chief executive identifies a problem area, he or she should meet with the appropriate executive and deal directly with the trouble spot. After all, if the right decisions are being made at the weekly cash meetings, the results should be apparent in the monthly summary.

The early warning system must be tailor-made for each company. It must direct management’s attention to the balance sheet, stressing the importance of cash management and assisting in rapid decision making..

The obvious mistake is a company’s lack of an early warning system. The mistake, though, that I’ve emphasized throughout my career is that of a company having too much breadth in its reporting package. As a mentor to CEO’s, I often coach them to focus on measuring the 5-7 most critical things that truly fuel their business – gross margin per unit, sales $ per headcount, customer satisfaction %, units produced per hour, etc. If a leader has the ability to correctly define those key drivers and motivate the entire team to focus on exceeding the goals, crises will either be identified early and effectively managed early or will be averted entirely.

Once the company has either used the early warning system to avoid or move out of the crisis, the frequency of the cash planning meetings can be reduced. But let us hope that the lessons learned are not forgotten as business improves!

Whether a Company is struggling financially or on the cusp of breakthrough growth, KGI can help. Our seasoned experts work alongside management to solve complex cash flow issues, operational challenges and other business crises. If liquidity or sale is needed, KGI provides a powerful combination of services and expertise to achieve outcomes that cannot be duplicated by other standalone consulting firms.