With the Covid-19 induced pandemic having disrupted economies around the world, companies have been in a fire fighting mode. And the impact is more magnified for SMEs, start-ups and scale-ups. The first most critical area of consideration is cash and liquidity management.
Business owners need to clearly have a contingency plan in place and be prepared for the worst-case scenarios.
Because of the prolonged shutdown, when we re-open, the recovery could be 'V' Shaped, 'U' shaped, 'W' shaped, 'L' shaped, or as the latest report by World Economic Forum puts it - tick mark-style SWOOSH shaped.
In each of the scenarios, there is a high risk that
a) Sales will dip and inventory would choke your balance sheet
b) Debtors won't pay up on time
c) Fresh fundraising for capex will certainly take longer, so would roll-over of existing lines such as Commercial Papers (CPs)
While certainly the intensity of the Covid19 impact will vary industries, with the ones like Food probably emerging unscathed and ones like Auto and Energy would be hemorrhaging.
Companies need flexible risk models, which take into consideration the operating risk. The challenge is to model how market price and sales volume changes would impact future profits. Instead of considering a string of certain and constant cash flows, one would need to model the uncertain cash flows, which can change because of any of the underlying factors - Cash Flow at Risk (CFaR) model
The need of the hour is to have cash flow models and perform simulations/ scenario analysis on a daily basis. So maybe you could do a 2-way data table on % Dip in Revenues and % Dip in Operational Expenses.
In terms of cash flows, this will help you find out your red zones, as also Containment Zones.
The models would help you devise strategies for:
a) Dealing with late payments customers
b) Predict the likely delay in financial closure and project implementation due to liquidity issues
c) Model a loss of revenue, and see how you would best deal with cash shortfalls and consequent delays in servicing debt
Also you could model the cash flow impact of any likely relief that your business could get due to government interventions.
If you are a start-up in India, with the double whammy of Covid-19 and restrictions on FDI from neighbouring countries, maybe consider your cash burn rates and how long you would survive with cash in hand. You might have to revise the periodicity of cash flow forecasting from monthly to even daily and to match expenditure with collections.
Your Banking & Treasury team would have to be on its toes - assessing whether there is one cash in the war-chest in different potential downside scenarios. In scenarios where debt covenants are likely to be breached, they should immediately get into negotiations with bankers for relaxations. Also, they should keep their credit rating agencies well informed so that there are no nasty surprises.
As Covid-19 takes its toll, a surge in insolvencies can be expected. In India, the government has decided to amend the Insolvency & Bankruptcy Code (IBC) to suspend up to one-year provisions that trigger insolvency proceedings against defaulters. Still, if you have cash in your coffers, these interesting times could throw up M&A targets at quite reasonable valuations. Cash flow modeling could help in agile decision-making, giving you a competitive advantage when opportunities may be available for short windows of time. Thus, it's all the more important to find out your Cash Flow bands.
Summing up; in preparing robust financial models, businesses can react to their specific reality and, possibly, forecast a brighter tomorrow.
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