Last Updated on Thursday, 15 September, 2022 at 1:50 pm by Andre Camilleri
Silvan Mifsud is director of Advisory at EMCS Tax & Advisory
Many economic indicators are flashing red. Virtually all economic forecasts predict an economic recession for the EU and US economy next year. It is within this context that many companies are now planning and preparing their annual financial budgets, at a time of high uncertainty. Budgeting-as-usual will very likely not be enough this time round, whereby budgets are prepared with a change here and there and then we hope for the best. What’s needed now is a budgeting process that prepares businesses to take swift action when needed. This year’s budgeting exercise should serve on making sure that mindsets are aligned on one key and central point – we need all hands on deck and we need to adapt quickly as the consequences of waiting are too big. Here are some pointers to move in this direction
Tune up your financial warning system
Most companies see danger too late. This is because they report financials and KPIs in an untimely fashion. This leads to a lot of postmortems and few possibilities to act in time. Another reason is that many businesses report on their incoming statements, hence tracking revenues and costs but not cashflow or balance sheet items. The three are tied together and need constant, updated and frequent visibility. It is only that way that business stand a chance at spotting slowing orders, growing inventory or delayed payments from debtors. So please make sure that now more than ever, you setup timely, frequent and comprehensive financial reporting. You need to understand where your revenues are most vulnerable and what a sudden drop in demand would do. What costs are at risk? What assets will be impacted? What signs will warn you?
Maximise cash generation
When times are tough cash is king. That’s doubly true as interest rates rise. Therefore, defending your working capital becomes even more important. This means that projects to improve cash generation include things like changing how you manage payables and receivables, reducing inventory and speeding distribution, should be given top priority.
Cost reductions: Reducing costs or turning costs from being fixed to variable will help the business survive better whatever happens ahead. Therefore you need to get specific about how much will be saved by when and by whom and then actively monitor progress. Decisions need to be takes on things like whether you are better off owning trucks or renting them? If it is cheaper having IT assets or migrating to the cloud? By outsourcing assets or processes, you can turn fixed costs into variable ones, which allows you gain the flexibility you need in uncertain times.
What would a mild, moderate, and severe downturn do to your business as a whole and to each part? Get specific. Where are you most vulnerable to inflation? A drop in demand? What actions would you take in each case? Who should take them?
Build out scenarios and responses to each scenario with levers you can pull at a moment’s notice. First is the easy-to-pull lever: actions that conserve cash with no long-term damage, such as an employment freeze or reduction in discretionary spending or a cut in marketing spend. The second lever — to pull if a downturn is fairly deep or long — is more painful. These are steps like cutting capital spending.
It is of vital importance that businesses prepare these scenarios now, when you don’t need them. That way, if business goes south the question becomes when to act, not what to do.
Don’t just extrapolate from last year on an overall basis
You need an active and detailed view of different costs and revenues and the drivers behind them. What is driving value in your business and where is value being destroyed? Knowing this is a powerful capability that can reveal opportunities for structural change and workload reduction and which efforts to boost and others to stop during an economic downturn.
I cannot stress enough on the importance on acting now on all of the above measures to prepare any business for tough times. Implementing such measures will also elevate any budgeting and planning process to a much higher and significant level. You will have a budget that’s designed for action, not just control.