Cashflow, Capital and Supply Chain – Planning for the New Normal
Without prompt and decisive action, the consequences of the pandemic could impair or even ‘kill’ the businesses many of us depend upon to earn our living. The purpose of this briefing note is to review the actions that should be considered now and developed as we move through lock down into the ‘new normal’. It’s essential to get the basics right and focus management resource on matters which are both urgent and important. Finance Directors can play a key role in ensuring a fact based, numbers driven approach is taken. The key issues are: – Cashflow forecasting. Cash is the life-blood of all businesses – its flow is critical to maintaining a healthy operation. In these extra-ordinary times the challenges in maintaining that flow reflect many of the disciplines we are all familiar with – forecasting, cash collection, supplier settlement, stock management, payroll etc – but with new challenges. – Working capital and managing the supply chain. To continue to trade, the supply chain must be maintained. Goodwill across the chain is important, and counterparties both up and down the chain will want to know that you are on top of your numbers and cash position, and can be relied upon to continue to service customers, and continue to pay suppliers – and employees. – Effective business controls. Processes to deliver the forecast cashflow need to be clear and robust and adjusted to the circumstances. – Communication to the key stakeholders. In a time of change and existential crisis people will be ’hungry’ for information. Make sure its timely, credible and reliable and covers the key stakeholder groups. Forecasting cash flow Managing cashflow means understanding what your inflows and outflows are, when they will occur, how likely they are, and which of them you can modify or change. No great technical skills are required to do this– a simple spreadsheet will suffice – but a good understanding of the business drivers and available ‘levers’ is essential. A detailed cashflow forecast should be prepared for at least the next 13 weeks. Whilst this exercise is typically left to the finance team, their business understanding may not be detailed enough. At a time where uncertainty is significantly increased – and so the risk of forecast error is much greater – your business forecast needs the input from each functional area of the business to ensure the forecast reflects a detailed and accurate understanding of the relevant area. Will that top tier customer really pay as usual at the month-end? Would one of your key suppliers agree to a deferred or part payment to help get you get past a cash ‘crunch point’? Many of these questions need input from other functions such as the sales team or purchasing function to be answered definitively. The ‘trick’ is to review all the inflows and outflows and challenge each one, with the managers responsible for, or closest to them. Teamwork and ownership are critical to preparing an accurate cash forecast. One approach would be to get a list of all suppliers by name, sort them into value by spend, and then starting with the highest spend supplier, review with the relevant internal business manager the need for that spend. Consider the scope to reduce it; delay and defer it; alternatives in the market for that supply; and the potential to extend credit terms with that supplier. Rather than try and stop all expenditure, take the time to understand the spend and look for mitigation. An obvious opportunity is taking advantage of the furlough scheme the government has created. It may be that it makes sense to ‘mothball’ much of the business operations, particularly if you are in a sector where revenue has dried up due to the lockdown. However, bear in mind that the minimum period of furlough is 3 weeks and that no work can be undertaken by furloughed employees – not even emails. Bear in mind that new expenditure on creating social distance and related measures to keep staff (and customers) safe, and ensuring that you can continue to operate may be required. That might mean adding physical screens; enhanced cleaning; PPE etc – all extra cash out. An advantage of spreadsheets is that they can be quickly and easily revised to present different scenarios and prepare ‘what if’ analysis. They can highlight where the key cash low points are – which is where the focus for action needs to be. Test and challenge all assumptions, and take the forecast out at least three months in detail. Whilst the immediate priority may be short term survival of the business, you should also use that detailed analysis and understanding of the immediate future to extend the forecast out further. Although the uncertainties and risk of change will make the projections less reliable the further in to the future they are extended, it is important to also look at the medium/long term cash needs. For example, if fresh equity will be required say in the next 12 months, the conversations and legal processes can be started in good time which will typically result in better terms, or at least more certainty. Working capital and managing the supply chain Try and understand the challenges your suppliers and customers are experiencing – or will experience – up and down the supply chain. As the refrain goes, ‘we are all in this together’ and gaining an understanding of their issues helps inform how to manage your business and predict the cash implications and consequences. As with the cash forecast, start with the most significant suppliers and customers. If your business holds stock, there are additional issues to be considered. Stock represents cash tied up in the business. Normally, stock levels are set in line with expected supply and demand patterns taking account of perishability. Clearly, at least two of these factors may now likely be very different. How secure is your supply? Is the lead time for supply increasing? Assess your vulnerability to key supplier failure, then work out a contingency for those you consider at risk. Has the supply price increased – or reduced? If your stock is for raw materials, how will you cope if you can’t get supply? If stock is finished items for re-sale and prices fall, how will you mitigate the reduced margin or loss on sale? If the cost of raw materials has gone down, can you negotiate a reduction in cost? For example, the cost of a barrel of crude oil in January 2020 has reduced from $60 to $11 at the time of writing. This means energy costs should have gone down. Are you seeing the benefit of this? Maybe your business has benefitted from customer stockpiling so far- leading to price inflation as demand outstrips supply. What will you do when this unwinds? Can you cope with growth? How will you credit check a new account in the current environment? Historic financial accounts may not help much (for example, the airlines now have a very different outlook) – and credit agency reports can change quickly. If possible, growth opportunities should not be passed up, but beware taking on a potential problem a competitor has declined – getting assurance on a prospective customers cash balance and understanding their own position in the supply chain (and so their risk of default) will be more important than usual. A specific area is dealing with your lenders. Ensure you understand the key terms, covenants, lending headroom and flexibility in your lending documents. Then, armed with detailed cash flow projections, engage as early as possible with your lenders. Effective business controls To make the forecast cashflow into the reality you want, effective controls will be required. Most businesses will have clear controls over cash out – but the controls over raising orders will often be less rigorous. Many managers believe that if they have budgeted an item or activity, then they are ‘authorised’ to spend the money and they will proceed to place an order. However, at a stroke, Covid19 has invalidated the assumptions the budget will have been based on – and its essential that everyone understands that all expenditure needs additional approval. Trying to exercise tight cost control when the supplier invoice is already on your desk is way too late. Reviewing expenditure with each functional head will help ‘buy-in’ and ensure a common understanding of what can and can’t be done in the new working environment. It will be helpful to start with identifying all non-contractual expenditure and re-assess what is necessary and re-classifying everything else as cancelled or postponed. In many cases, a review of already contracted spend will be necessary – it might be contracted, but are there exit or delay provisions in the agreement? Is it possible (and desirable) to claim Force Majeure? If your back is really to the wall, it may be that the penalties for breach of terms are less severe than the cost of continuing to honour the terms. You may find that the contractual counterparty has their own problems with meeting contracted terms and will be willing to suspend if not terminate the agreement. However, the personal and business ethics of this also need consideration, and aside from the legal aspects, bear in mind that reputational damage can persist for a long time. Your brand reputation will ultimately benefit by conducting activity in a responsible and ethical manner, or as the government put it, thinking of others first and acting with decency. Clear communication back to stakeholders to manage expectations will be critical. Manage your investors tightly, seek alternative sources of supply, establish a chain of command to cope if key decision makers are sick themselves (including relevant authorities with lenders etc). Lastly, whilst focused on service and safeguarding employees, don’t forget about the physical security of your assets. Reported crime rates have fallen since lockdown began, but the risk of increased social inequality may lead to additional risks on them and malicious damage. Communication Communication is key. Communication with all stakeholders – employees, suppliers, customers, banks and shareholders. Having a detailed cashflow forecast gives a numerical basis for that communication – and whilst not (yet) factual, it is a ‘map’ against which to chart the course through these uncertain times. It also provides a tangible focus for the business to direct and assess its effort. The next issue is how to manage the communication – giving the right messages to the right people, at the right time. Direct communication from the Finance Director or Managing Director may give additional credibility to the message. For example, late payment to suppliers should ideally be by agreement – and when a later settlement date is agreed, that must be adhered to. Suppliers will be understandably nervous that a request to defer payment may be a lead indicator that they won’t get paid at all. Assurance from the business leaders may make the difference. Summary and Conclusion Now, more than ever, a numbers driven approach will be critical to successfully navigating through an uncertain world. Finance can take a lead role in managing that approach levering the skills and experience of the other business functions; understanding the supply chain; implementing appropriate controls; and providing credible communication to stakeholders. Lastly, try and keep an eye on the medium-term trading environment. This crisis – or the effects of it – could be persistent. Where are the opportunities? What will happen next to the fiscal system when the government needs to fund the emergency measures? What new sources of finance can be made available? Find some time to think about your business model and how you can make it more robust, and perhaps take advantage of the massive change we are likely to see in many aspects of business life in the coming months. The UK government has developed a number of measures to help ease cash pressures and relax insolvency liability risks for directors, and these will be covered in a subsequent article. We are available to discuss any finance related concerns you have regarding current working practices or changes you may introduce.