Last week, Focus Management Group discussed creative accounting methods related to the Payroll Protection Program (“PPP”) and the income statement. In this article, we will discuss the accounting for the PPP funds and working capital management.
What to Watch For?
We are considering a company that received $1.8 million under the payroll protection program. And, the company’s income statement performance remains unchanged from the prior year.
We are now considering working capital impacts. First let’s analyze the impact of the company keeping its cash versus the company using the cash to pay down the line of credit. Then, let’s analyze the impact of a slowing in the accounts receivable, inventory, and accounts payable turnover rates and the company borrowing under its line of credit to fund its working capital.
The first table shows a sample company, with a simple change. In option 1 the company keeps its cash and its line of credit outstanding. In option 2 the company pays down its line of credit. Assuming the accounts receivable, inventory and accounts payable turnovers stay the same, the company would either have a higher cash balance or additional availability under the line of credit which could be used to fund expenses.
In both situations it will be key for a lender to track the cash balances, the working capital components, and the line of credit – especially during the eight weeks immediately after funding of the PPP.
In the next table we consider a company using its PPP loan to pay down the line of credit and then the line of credit needs with a slow down in the turnover of accounts receivable, inventory and accounts payable.
In Option 1 the line of credit is paid down to $638,000 and the company would borrow money under its line availability to fund its operating expenses.
In Option 2 the receivable turnover increases from 35 days to 70 days and inventory turnover increases from 45 days to 60 days. At the same time the company is able to stretch its accounts payable and increase the days outstanding from 25 days to 50 days. Even though the PPP loan proceeds are used to pay down the line of credit, the slowing in the turnover of working capital components means the company needs to borrow nearly the same amount under the line of credit to support working capital needs.
In the next table these two options show the difference in outstandings under the line of credit, and the increased need for working capital. The Company needs $1.25 million of additional access to cash for working capital. If the lender continues to use the previous advance rates and does not impact availability for growth in accounts payable, the line of credit could increase approximately $1.7 million. And, the PPP loan could be used to fund operating expenses.
The concern is that the underlying assumptions of collectability of accounts receivable, sell-ability of inventory, and ability to grow accounts payable put a working capital lender at potential risk.
What should a lender or reviewer of financial statements watch for?
From a working capital perspective, asking questions and tracking changes over time is going to be very important. Here is a short list of questions to ask and additional reporting to request:
-Accounts Receivable
Track the aging of receivables on a weekly basis.
Track the roll forward of receivables on a weekly basis.
-Inventory
To the extent possible, ask for an aging of inventory and receive that information weekly.
Track the inventory by components such as raw materials, work in process and finished goods.
Track outstanding purchase orders and ask for matching to the inventory.
-Accounts Payable
Track the aging of payables on a weekly basis.
Track the roll forward of payables on a weekly basis.
Track supplier lines of credit and the amounts outstanding.
-Cash
Track book and bank cash balances weekly.
What are the next steps?
Lenders and investors are going to hear the Covid-19 excuse for the foreseeable future. We all know there are positive and negative impacts to businesses as a result of the virus and none of us should make light of the seriousness of the virus and the impact on business.
But, as readers of financial statements, we all need to make sure we don’t hear what we want to hear, or make excuses for performance that are unfounded. Ask questions.
Focus Management Group is available to assist in developing tracking mechanisms with businesses that can help clarify performance impacts, and working capital impacts. Call us to discuss what you are seeing and the questions you have.
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