“The most valuable commodity I know of is information.”
It’s a movie line turned business truism – one that’s particularly true in private equity circles, where the unknowns are what create investing risk. Yet, despite all the tools we’ve added to the standard PE toolbox over the last decade – the value creation levers, the operating paradigms, the management talent assessments – we haven’t universally adopted the one tool that can provide fund sponsors with near omniscience about the state of their portfolio: cashflow forecasting.
Cashflow forecasting – particularly in the form of a 13-week liquidity forecast – uncovers flows in working capital and short-term debt needs. It offers fund sponsors and company management clarity into both the sources and uses of cash. And, it can shine a light on the shadowy reasons for portfolio company underperformance.
So, if it’s so darn helpful, why isn’t it standard practice? Let’s blame the myths surrounding when and how forecasts should be used, primarily these top four:
1. It’s a train wreck
When the wheels go off the rails, everyone suddenly wants a forecast. Now, that certainly makes sense. When the portfolio company is looking at a moment of illiquidity, it’s logical to investigate its unforeseen causes.
But those events and causes didn’t need to be so unforeseen. Cashflow forecasts can be used for far more than just train wrecks and turnarounds. The diagnostic clarity they offer on the health of a company (and on the longevity of its health) benefits companies that are only slightly underperforming, or simply not meeting expectations. It also benefits companies where nothing seems wrong, at least on the surface.
In both latter scenarios, cashflow forecasts can be used preventatively – to head off a crash and to keep the train headed in the right direction (or re-route, as necessary).
Years of working in performance improvement engagements have taught me this: Fund sponsors don’t like bad news. But, bad news – delivered well in advance, when there’s ample time to find a path to progress – is far better than surprises.
Cashflow forecasts can eliminate those surprises, providing an accurate picture of operational liquidity and a means of identifying a company’s potential trapped value, from which sponsors and management can focus on effective and targeted value creation plans.
2. It’s a death sentence
Hand-in-hand with the train wreck mythology is the belief that when a cashflow forecast is “ordered” for a company, it’s already marked as dead.
The orientation is simply wrong. Cashflow forecasts are not autopsies, they’re diagnostic tools. Find the problem, treat the problem, heal the company.
When used to their best potential, forecasts quickly illuminate the underlying drivers of current/future underperformance in the business. They offer sponsors and company management the opportunity to understand the magnitude of a problem and the clarity to build a path, not to recovery, but to success.
And sometimes, forecasts don’t indicate trouble at all. Instead, they’re used to guide the path toward continued success by informing future scenario planning. How much slack do we have to weather unforeseen difficulties? The more cash, the more slack.
3. It’s just another KPI
So many performance indicators speak to the health and prosperity of a business: regional growth, customer acquisition cost, net promoter score, etc.
Management – particularly inexperienced CFOs unfamiliar with institutional ownership – can speak to their company’s stellar performance against any number of metrics: “This is growing, that is shrinking, we’re doing great!”
And yet, the business just doesn’t seem to be operating to its full potential. That’s because cash doesn’t lie. If cash has been flat, despite all of the progress against other variables, you haven’t moved the needle.
Cash is not a KPI, it’s the KPI
4. It’s already done
This myth is simple to disprove. Liquidity forecasting isn’t part of the CFO’s wheelhouse. It’s not taught at business school, and your portfolio company and their finance team are likely not doing it.
Nor is it easy to do. It usually involves investigating individual flows – cash receipts, payroll, taxes, operating expenses, note/lease payments, accounts payable, etc. – from disparate reporting systems to create a complete and holistic working capital fabric.
But that, of course, doesn’t mean it shouldn’t be done. The benefits to its completion far outweigh the difficulties in its execution.
The truism, it turns out, is entirely true: The most valuable commodity is information. And if cash is king, then information about it – its uses, sources, longevity – is paramount.
And so, it’s time. It’s time to make cashflow forecasting a staple in the PE toolbox.
Anthony Horvat is a managing director at Accordion, the private equity financial consulting and technology firm focused on the office of the CFO.