Dr Krzysztof Legutko, an expert in the Structured Finance Department at Bank Millennium, talks with the President of XTRF and a business advisor Andrzej Nedoma
Krzysztof Legutko: We meet remotely to talk about financial management in a crisis.
In difficult times when revenues are falling, CFOs in companies are closely watching expenses. And they reduce costs. Traditionally, the tool supporting their decision making is the budget. A budget is a financial plan drawn up for a specific time horizon. It sets goals that the company intends to achieve as well as methods and means that will be used to achieve these goals (sources & uses).
Is a budget needed?
Yes, because it allows you to formulate a strategy and development directions coherent for the entire company and build financial forecasts. It is a tool for optimizing decisions and their implementation.
In the event of a change in the economic climate, the budget should be flexible and provide for various variants of the company’s operations.
However, what is especially necessary now is cash flow. Cash flow is about planning cash inflows and expenses. And also for such cash management to maintain the financial liquidity of the company, i.e. so that it is neither too much (money should work) nor too little (when you need to find sources of financing the lack of cash). This means that, especially in times of recession, the company should monitor cash inflows and expenses on a daily basis.
What can you do to optimally manage your company’s liquidity?
Here are some simple ways:
- Settle obligations on time but not before date;
- Obtaining the cheapest possible sources of financing;
- Locate temporary surpluses as advantageously as possible, taking into account the liquidity of the asset and the inflation rate;
- Effectively manage receivables, e.g. use factoring to quickly convert receivables into cash;
- Manage inventories effectively, which involve specific costs, e.g. storage, insurance, a decrease in their value as a result of a change in the market price (a good example is the clothing industry and recently the fuel market where negative oil prices in the US are associated with both a decrease in demand and high storage costs).
Andrzej Nedoma talks about the practical aspects of financial management in times of crisis in a technology company:
The crisis introduces great uncertainty. You cannot rely directly on the budget in business decisions, as the realization of the revenue side is very uncertain in a crisis. In turn, the realization of costs without the realization of revenues leads directly to a loss of financial liquidity. That is why the report presenting the forecasted free cash position is definitely more important.
Such a report should present the state of cash “for today”, i.e. for the date of the report, and the forecasted state of cash for each subsequent week, including all contracted costs (which reduces cash) and the realization of all already contracted revenues (which increase the amount of cash in future). Contracted costs are all the commitments that the company has already made – that is salaries, obligatory insurance, social fees and taxes, office rent, credit and leasing installments, costs of already planned business or conference trips, standard back office costs, etc. Planned but not contracted costs should not be included in this category. For example the costs of new employees (planned to be hired in future), the costs of developing new products, not running marketing campaigns, etc. The goal is to include only those costs that have already been committed to by the company, in the form of a signed contract or other binding agreement.
Similarly, we recognize the expected revenues in the cash-flow report. There, we also want to see only those items for which a sales invoice has already been issued and the realization of revenue no longer requires a new decision from customers. So we want to take into account only confirmed and practically certain income.
In this way, we receive a report showing forecasted changes in cash, taking into account already contracted (and therefore almost certain) costs and revenues. It may look like this:
|date||week||Cash balance (opening)||Recurring revenues||Revenue from new sales||costs||Change in cash||Cash balance (closing)|
|2020-05-04||2020_19||2 066 027||129 132||923||641 770||-511 716||1 554 311|
|2020-05-11||2020_20||1 554 311||52 490||0||227 963||-175 473||1 378 838|
|2020-05-18||2020_21||1 378 838||193 410||17 835||216 370||-5 125||1 373 713|
How to analyze such a report and what conclusions can be drawn from it?
First of all – it is the date of when we get to zero cash. For most companies, no new sales (and this one is not included in the cash-flow report because it is not certain) results in a gradual spending of cash reserves to cover costs, and therefore this cash will be fully spent at some point. The question of how far (or close) ahead of us is this moment. In times of crisis, when new sales are difficult to generate, this information says a lot about the company’s financial security.
Another issue is – how important are the contracted revenues expected to be collected in the coming weeks and is the positive cash balance dependent on them. There is always a risk that the customer will not respect the payment deadline, or worse, that the crisis situation on the customer side will prevent him from executing this payment at all. This risk additionally affects the company’s financial security and must be taken into account.
The third issue is analysis as to how much it is necessary to reduce costs, in order to postpone the moment of “zero cash” by one, two or three quarters, depending on the forecasted period needed to generate new sales which would ensure the financial stability of the company.
From such a report you can read a lot more information, which will result in your high awareness of the company’s situation and thus in wise business decisions. One thing is certain – in the current situation, “making friends” with such a report is a must and it should be taken into account with the vast majority of business decisions, whether related to obtaining external financing, pricing policy, cost control, etc.