Strategies to Manage Through Upcoming Leverage and Covenant Challenges

Warning signs are flashing for corporate borrowers in the current market, and more executive teams are focused on managing through (or seeking to avoid) leverage and covenant issues with lenders. With interest rates expected to continue their rapid ascent into 2023 to fight off record high inflation, and increased talk of an upcoming recession (and resulting weaker EBITDA), finance teams are dusting off their cash management playbooks to closely monitor their leverage/credit metrics and ensure they remain in compliance with existing lender covenants.

“Being proactive in this environment is absolutely critical, and the more you can get ahead of potential financial stress and covenant issues, the more options there will be to navigate potential challenges,” says Jeremy Falendysz, Managing Director of UHY Corporate Finance. “We have been engaging with a growing number of executive teams in the past several months on FP&A analyses, forecasting, cashflow management activities, and other efforts to do just that.”  

In addition, executives are taking a closer look at their company’s internal processes to identify efficiency opportunities.  “Many clients are exploring ways to become recession resistant through business process, supply chain, and technology improvements,” explains Dan Bruce, Senior Manager of UHY Consulting.  “Documenting and analyzing current state processes identifies opportunities to free up cash flow through the elimination of non-value add, wasteful activities.” 

Challenges are on the horizon, often driven by:

• Inaccurate/stale 13-week cashflow forecasts obscuring financial planning
• Forecasts underestimating the extent of interest rate increases (or other outdated assumptions)
• Out-of-date 2023 cashflow forecasts with too little detail and a lack of executive focus
• Customer payments being stretched out and/or not managed proactively enough
• Lack of internal resources focused on the strategies necessary to identify/manage these issues
• Fear of communicating potential challenges directly with lenders

Proactive strategies to implement today:

Review, refine, and frequently update a detailed, near-term (weekly) and long-term (monthly) cashflow forecast

• Ensure that you have a sufficiently detailed forecast in place that (i) builds up revenue on a granular (customer/product/project) basis, (ii) reflects input from all business unit managers, and (iii) is updated at regular intervals
• Mind the long-term forecast closely as this is the best way to stay ahead of potential future challenges
• Record and understand where discrepancies are happening between the Budget vs. Actual periods in your 13-week cashflow forecast (and the long-term forecast)
• Increase communication with customers to better understand scheduling patterns and increase accuracy of forecasts

Stress test scenarios, near-term and long-term

• Retest forecasts under multiple stress scenarios relevant to your company (e.g., higher interest rates, increased and/or persistent cost inflation, supplier/input delays)
• Results can be scary, but it will allow you to explore potential solutions before they occur, and identify flexibility in the broader financial system within your organization

Review and execute near-term liquidity opportunities

• Proactively seek to identify operational and capital expenditures that can be deferred, reduced, or eliminated
• Ensure A/R is being proactively and rigorously managed internally and with customers (often requires executive reporting and internal accountability to truly optimize)
• Prioritize A/P and have clarity around communication and timing of changes to terms
• Establish inventory on hand min/max boundaries to prevent excess cash tied up in inventory
• Review payment and credit terms with suppliers and vendors

Review and execute near-term cost reduction strategies beyond liquidity

• This is something companies should be doing in the normal course, but becomes increasingly critical in times of financial stress
• Identify any unprofitable/less-profitable customers, products, and/or projects that can drive margins higher
• Explore potential price increases (while many executives are hesitant here, customers are likely accepting price increases from your peers in this environment!)
• Coordinate and consolidate shipments to reduce shipping costs and maximize container density (for overseas shipments)
• Review and assess current state processes and technology to identify efficiency opportunities
• Develop a strategic plan and communicate it throughout the company to ensure everyone is working to accomplish the same goals

Communicate early and often with lenders

• Confirm alignment on reporting and covenant expectations well in advance of any actual issues
• Demonstrate the steps your team is proactively taking (including potentially engaging external resources/professionals)

Seek counsel from trusted advisors navigating these issues in today’s market

With a diverse portfolio of financial and consulting services, UHY’s innovative investment banking and consulting professionals can assist with planning and preparation for increased uncertainty and a potentially challenging market ahead. We understand the most important challenges facing business owners and executive teams and are well-equipped to help your organization successfully tackle these issues as they arise.