TMA Cash Flow Management 2 — Questions and Answers
Question 1: What is 'Days Sales Outstanding (DSO)' and why is it important in a turnaround?
- The number of days inventory sits before being sold; it measures operational efficiency
- The average number of days it takes to collect payment after a sale; a high DSO strains liquidity (Correct answer)
- The number of days between ordering and receiving inventory
- The average days between interest payment dates on outstanding debt
Correct answer: The average number of days it takes to collect payment after a sale; a high DSO strains liquidity
DSO measures the average time to collect receivables; reducing DSO accelerates cash inflows and is one of the fastest ways to improve liquidity in a distressed company.
Question 2: What is 'factoring' and how is it used as a cash management tool in turnaround situations?
- Selling accounts receivable to a third party at a discount to receive immediate cash (Correct answer)
- Refinancing fixed assets by selling them and leasing them back
- Issuing new shares at a discount to attract distressed debt investors
- Converting vendor payables into long-term notes to extend payment terms
Correct answer: Selling accounts receivable to a third party at a discount to receive immediate cash
Factoring involves selling accounts receivable to a factor at a discount, providing immediate cash and transferring collection risk, which is useful when a distressed company needs quick liquidity.
Question 3: In a turnaround, 'working capital optimization' primarily focuses on which of the following?
- Increasing capital expenditures to improve long-term asset efficiency
- Reducing the cash conversion cycle by managing receivables, inventory, and payables (Correct answer)
- Hiring additional staff to process transactions more quickly
- Expanding credit lines to fund day-to-day operations
Correct answer: Reducing the cash conversion cycle by managing receivables, inventory, and payables
Working capital optimization reduces the cash conversion cycle—the time it takes to convert investments in inventory and receivables back into cash—by collecting faster, reducing inventory, and extending payables.
Question 4: What is a 'cash dominion' provision in an asset-based lending agreement?
- A lender's right to seize all company assets if a covenant is breached
- A requirement that all customer payments flow through a lender-controlled account and are applied to reduce the revolving balance (Correct answer)
- The borrower's right to draw funds at will from the revolver without lender approval
- A minimum cash balance requirement maintained in a segregated reserve account
Correct answer: A requirement that all customer payments flow through a lender-controlled account and are applied to reduce the revolving balance
Cash dominion (or deposit account control) requires customer payments to be swept to a lender-controlled lockbox, with proceeds applied to reduce the revolving loan balance, giving lenders tight control over the borrower's liquidity.
Question 5: Which of the following is an example of a 'quick win' cash generation strategy commonly employed at the start of a turnaround?
- Launching a major new product line to increase revenue
- Divesting a core business unit to raise capital
- Collecting overdue receivables and suspending non-essential capital expenditures (Correct answer)
- Refinancing all long-term debt into equity
Correct answer: Collecting overdue receivables and suspending non-essential capital expenditures
Quick wins in cash generation focus on immediate, low-complexity actions like accelerating overdue receivable collections and halting discretionary capex to stabilize liquidity without requiring complex restructuring.
Question 6: What does EBITDA stand for, and why is it commonly used as a proxy for cash flow in distressed company analysis?
- Earnings Before Interest, Taxes, Depreciation, and Amortization; it approximates operating cash generation before non-cash charges and financing costs (Correct answer)
- Estimated Base Income Tax Deduction Assessment; it measures tax efficiency
- Earnings Before Investment, Trading, Debt, and Acquisitions; it measures free cash flow
- Enterprise-Based Income Tax and Debt Assessment; it calculates total debt service capacity
Correct answer: Earnings Before Interest, Taxes, Depreciation, and Amortization; it approximates operating cash generation before non-cash charges and financing costs
EBITDA adds back non-cash charges (D&A) and financing costs to net income, providing an approximation of the cash a business generates from operations before debt service, useful for comparing distressed companies.
Question 7: In a turnaround, what is the purpose of a 'vendor payment stretch' strategy?
- To accelerate payments to critical vendors to secure favorable pricing
- To deliberately delay accounts payable payments beyond normal terms to preserve cash (Correct answer)
- To convert vendor payables into equity stakes
- To pay vendors in installments using newly issued company debt
Correct answer: To deliberately delay accounts payable payments beyond normal terms to preserve cash
Stretching vendor payments extends the time a company holds onto cash by paying supplier invoices later than contractual terms, temporarily improving liquidity, though it risks supply disruptions if not carefully managed.
TMA Cash Flow Management 2
What is 'Days Sales Outstanding (DSO)' and why is it important in a turnaround?