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Should your Business Perform a Liquidity Audit?

Financial Restructuring and Bankruptcy Alert | November 25, 2008
By: Steven Ostrow

American businesses and investors are facing unprecedented challenges as a result of the economic downturn and, in particular, the current credit crisis. The stock and credit markets have been under siege.  Major financial players such as Bear Sterns, Citigroup and Lehman Brothers have been bought-out, bailed-out or bankrupted. 

Companies are reevaluating their business plans, reviewing their performance and cutting costs. As part of this process, businesses should consider performing a liquidity audit to ensure that they have, and will maintain, sufficient revenue and capital to fund necessary operations, and to make critical acquisitions or capital investments in order to ride-out the economic storm and hopefully prosper. Significantly, financial institutions have restricted or cut-off the flow of financing. 

While market events continue to unfold and make daily headlines, businesses should take concrete steps now to maintain or improve their financial position by conducting a liquidity audit. The audit assesses the status of your cash flow and credit facilities as well as the security of your deposits and short-term investments. Depending on your specific circumstances, the liquidity audit should review the following:

Cash Flow

Firms should vigorously check and update the creditworthiness and status of new and existing customer accounts and insist upon timely payment within contract terms. They should consider requiring collateral, advance deposits or COD arrangements before conducting further business with delinquent accounts or customers having financial difficulties. This will help to secure payments, improve your cash flow and avoid exposure to preference claims if your customer subsequently files for bankruptcy. You will need to understand your options and risks if you desire to continue to do business with, or become a creditor of, a company filing for bankruptcy.  

Financing Status

Businesses should carefully review their credit facilities to determine the availability of lines of credit and access to your accounts. Should your company draw down on its remaining line of credit? What will occur if your company cannot replace a letter of credit that will expire shortly? Should you contact the lender to ascertain its current lending policy regarding renewals, new loans or potential interest rate increases? How will your loans be affected if the lender is being taken over by another financial institution or federal receivership such as the Federal Deposit Insurance Corporation (FDIC)?

Because traditional outlets are drying up, borrowers must investigate other sources of financing such as equity investors, venture capital firms or perhaps an SBA loan, if eligible, where a significant portion of the lender’s loan is guaranteed by the Federal Government, which reduces the lender’s risk. Alternatively, you may be forced to consider restructuring your credit facilities with an existing lender, whether or not you are current in making payments. You also should determine whether your company is in compliance with its loan covenants to identify problems before reporting deadlines or annual reviews approach. Addressing issues ahead of time may avoid giving the lender a possible basis to deny further credit or reject a loan modification.  

Your business may be eligible to defer paying taxes on income resulting from the forgiveness of a loan obligation in connection with a restructuring agreement with your lender. Under the American Recovery and Reinvestment Act of 2009 (known as the Stimulus Bill), signed into law by President Obama on February 17, 2009, taxes on income recognized from certain discharges of debt may be deferred for the first four or five years with the income recognized ratably over the following five taxable years.   

Cash Deposits and Brokerage Accounts

How safe are your cash deposits and short-term investments? Now is the time to review deposit and investment accounts to determine whether your funds are protected under the insurance programs of the FDIC and Securities Investor Protection Corporation (SIPC). The FDIC program protects certain deposits in insured banks; the SIPC program protects certain investments with insured securities dealers. If you are unsure whether a financial institution or brokerage firm is covered under these programs, you can look them up at the appropriate website (www.fdic.gov and www.sipc.org). Coverages and limitations vary by program as follows:

FDIC Program

Under the Emergency Economic Stabilization Act of 2008, which former President Bush signed into law in October 2008, for ordinary deposit accounts, FDIC coverage protects $250,000 (formerly $100,000) for each depositor at a financial institution. Joint account holders are protected up to $500,000 in the aggregate. The limits are per depositor at the financial institution and not per account. In other words, a single depositor with five accounts each with a balance of $100,000 for an aggregate amount on deposit at the institution of $500,000 is protected only to the extent of $250,000. If the accounts are held jointly instead of by a single depositor, $500,000 in the aggregate is protected. For individual retirement accounts (IRAs), the limit is increased to $250,000 per depositor.  Importantly, the increased coverage limits for deposit accounts, but not IRAs, will expire on December 31, 2009.   

If you have funds at an insured institution in excess of the deposit limit, you could move the excess to another federally insured institution. Several savings banks have joined a consortium of banks to make it easier to move funds around from bank to bank to seek maximum insurance protection. Through the so-called Certificate of Deposit Account Registry Service or CDARS, you can secure FDIC protection for up to $50 million by having the service move excess balances to other covered banks, leaving no more than $250,000 at any one institution. You can learn more about this consortium at their website www.cdars.com.

SIPC Program

The SIPC program protects customer accounts from certain losses at member brokerage firms. SIPC extends $500,000 of protection to a customer, of which, as much as $100,000 can be for cash. Investors are protected for losses attributable to ownership of stocks or bonds which were supposed to be held in customer accounts when the member firm ceases to conduct business. SIPC, however, does not cover losses attributable to market fluctuations.  

We welcome the opportunity to help your business perform a liquidity audit and successfully navigate through the credit crisis storm. If you have questions or would like additional information, please contact Steve Ostrow (ostrows@whiteandwilliams.com; 212.714.3068) or another member of the Financial Restructuring and Bankruptcy Group.

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.
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