Basic, lesson 1 of 3
How companies get into trouble
Companies file when they run out of cash or cannot refinance, not when they post a loss. Separate the liquidity problem from the solvency problem and you know which fix can work.
9 min, 3 checks
1Liquidity and solvency
A liquidity problem means the company cannot pay what is due in the next few months, even if the business is worth more than its debt. A solvency problem means the business is worth less than its debt, whatever the cash position today. The fixes differ. Liquidity can be bought with time and new money. Solvency needs someone to take a loss, usually by swapping debt for equity.
- Revolver drawn to the limit, often right after a weak quarter.
- Payables stretching: the company pays suppliers later, and suppliers start asking for cash up front.
- Late financial reports, auditor going concern language, or a change in the CFO.
- Loans and bonds trading well below par before anything has been announced.
- A maturity within 12 to 24 months that no lender has offered to refinance.
Check 1
A company is worth $500m and owes $300m, but $120m of that is due next month and it has $20m of cash. What kind of problem is this?
2Runway and the maturity wall
Worked example
Dunmore Plastics
- 1EBITDA $30m, cash interest $35m, capex $10m. The company burns $15m a year.
- 2Cash $20m. Revolver: $50m committed, $30m drawn, so $20m undrawn. Liquidity $40m.
- 3Runway: $40m / $15m = 2.7 years.
- 4But the $300m term loan matures in 18 months. A new lender would lend about 4.0x EBITDA: $120m. The refinancing gap is $180m.
- 5At 6.0x EBITDA the business is worth $180m against $330m of debt.
The runway says three years. The maturity says 18 months. And at $180m of value the company is insolvent, so time alone will not fix it. Expect a debt for equity restructuring.
Check 2
A borrower has $12m of cash and $18m undrawn on its revolver. It burns $20m a year. How many years of runway does it have?
Check 3
A $250m loan matures next year. EBITDA is $40m and new lenders would lend 4.5x. What is the refinancing gap, in $m?
Terms in this lesson: Revolving credit facility, EBITDA, Capital expenditures.
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