Cash flow is the life blood of all businesses.

There are many examples of business collapses due to cash flow deficiencies, particularly in seasonal businesses. Cash flow issues can occur for many reasons and may be exacerbated by the inability to obtain appropriate credit facilities for the business.

A cash flow waterfall is a very simple method of managing a business's cash flow during a restructuring to assist with its survival. At its core is the assumption that cash flow is insufficient to pay all outstandings and, therefore, cash must be allocated in a manner which best allows the business to continue. Some deferment of payments is essential.

Monthly cashflow cascades down a list of priority payments commencing with fixed costs such as rent, utilities, employee salaries and other priority payments. General creditors are then paid on an oldest to newest invoice basis to minimise the payables ageing schedule. Depending on cashflow levels, it may then be possible to keep general creditors within a payment period such as 30 or 60 days.

Creditors who are aware of the business's cash flow issues may be more willing to extend payment terms where they can see their invoices are being paid on a regular yet slow basis. It is generally not in anyone's interest that the business collapse.

There will always be creditors who wish to jump to a higher level of the waterfall and it is management's responsibility to manage their expectations. Priority given to one creditor may cause a stampede of other creditors demanding equal treatment.

It may also be necessary to deal with rumours regarding the solvency of the business. To do this effectively, you may need to create exceptions to the cashflow waterfall approach.

One business with severe cash flow issues that I restructured faced an interesting situation. Rumours of insolvency started spreading through one part of the country. As best as we could determine, the rumours centred around a particular group of trade creditors who were owed a limited amount of money but it had been outstanding for many months. A failure to stamp out these rumours may have caused angst amongst the broader creditor group in other parts of the country. By paying out these creditors in full, we were able to contain the rumours and continue to manage the other creditors using the cashflow waterfall mechanism.

Cash flow waterfalls work best in jurisdictions which are more debtor friendly. In these countries, civil proceedings may be arduous affairs and bankruptcy proceedings may be considered only as a last resort. These jurisdictions allow more latitude in negotiations with creditors than may be possible where trade debts can be easily enforced.

Directors of companies also need to be mindful of the responsibilities of trading while insolvent. In some Asian countries, this is less of an issue and there may be no personal liability placed upon directors for trading while insolvent. In some cases, it is lenders who are penalised for extending credit to insolvent companies rather than the directors. Legal advice is necessary to ensure compliance with local laws.

PELEN

November 2017

The content of this publication is intended to provide a general overview on matters which may be of interest. It is not intended to be comprehensive. It does not constitute advice in relation to particular circumstances nor does it constitute the provision of legal services, legal advice or financial product advice.