Business plans were ripped up overnight and liquidity became the only game in town as the pandemic forced us all into multiple lockdowns throughout 2020 and 2021. But it appears that despite these troubles many businesses and individuals survived the heights of the pandemic in much better shape than many economists expected.
Pent-up demand has been huge, much more than anticipated, and at the same time supply chains have taken time to reactivate. The pandemic rages on and has certainly not stopped being a disruptive influence in many parts of the world. Central banks appear shocked by higher-than-expected inflationary pressures, even before Russia invaded Ukraine and exacerbated rising fuel prices and disruptions to food supplies. All of this is now driving an inflationary-driven recession in many economies as individuals and businesses start to reign in expenditure and a cost-of-living crisis unfurls.
Another curious element of the current situation is the shortage of labour. Where has everyone gone? Job vacancies have never been so high and airports, hotels and essential services are all experiencing huge problems finding the staff needed to operate them. Although some job losses are inevitable, we could be facing a recession without significant unemployment and a cost-of-living crisis at the same time as a record number of people in work – truly strange times.
The treasury response – forecasting
Forecasting is the early warning apparatus the business really needs in a crisis. In a rapidly changing economic environment, the value of regular meaningful re-forecasting comes into its own. However, forecasting must have the following characteristics to be truly useful:
Table 1: forecasting is your greatest ally in a rapidly deteriorating environment
By integrating cash and profit and loss forecasting the process addresses several critical areas the business must stay on top of in a deteriorating environment:
- Liquidity: While the design of adequate committed facilities is a long-range planning process the forecast is essential to test if headroom is set to be challenged in the shorter term
- Business model: In an integrated forecast the impact on sales and costs not only feeds into liquidity but is an early warning sign as to the ability of the business model and the strategy to perform. Identifying as early as possible whether an impact on the business is short-term in nature or signalling a fundamental issue gives management the best chance of adapting.
- Short-term targeting: A best-in-class forecasting process helps management set short-term targets. For example, the accounts receivable team could be tasked with identifying accounts at risk and prioritising collection and close contact with these.
To make it clear, the process I describe above is not driven by an automated AI-type technology environment. It is a bottom-up process with input from operational teams on the front line. Sure, these teams themselves might be using technology to come up with their own specific part of the forecast. For instance, sales might be using AI to predict walk-in spend and product mix.
The reason this bottom-up approach is critical is twofold:
- It not only gets the best data available into the forecast, but it also forces the teams doing the forecasting to appraise the situation as they see it on the ground and report it back as accurately as possible.
- This in turn gets the whole organisation working in common and addressing the problems they identify in real-time. A forecast prepared within the finance department, especially with heavy reliance on technology evokes little ownership by the business.
Other considerations
There are of course many other things treasuries can do to support their businesses through these challenging times:
Hedging: We have seen big spikes in commodity prices, but as we speak there are signs that these may have passed their peaks. Many treasury policies allow for some judgement as to the level of hedging, usually price fixing, the business can operate at. Revisiting these levels regularly and reviewing them in line with current forecasts for sales, consumption and margin may be relevant in certain industries. This can be a very complicated area as any effective policy must also take account of how quickly, and to what extent, the business can reprice on the sales side. Hedging these risks is all about buying time for the commercial response and protecting against the extreme scenario that causes wipe out.
Insolvencies, bad debts and supply disruption: Staying close to, and supporting, if necessary, critical suppliers and customers is important. With many businesses close to “zombie” status, propped up by Covid support, which is now being withdrawn, expect the level of insolvencies to hit very high levels during this recession.
Fatigue: This is tough. Many individuals are close to burnout. Treasury has been in the eye of the storm for a while now, everyone is struggling with workload, the demands of a world still heavily disrupted by Covid and the cost-of-living crisis on their own doorsteps. Prioritising key tasks and projects and being pragmatic about what is achievable is more relevant now than ever.
Working capital: In the very short-term working capital’s impact on cash can far outweigh the reduction in profit. Understanding the effect of a downturn in the business on working capital can be complicated. For example, looking carefully at the level of inventory being held is a fine balancing act between supply chain disruption and tying up cash.
A final word if I may on ESG. We can only expect the world to become a harsher environment over the next few decades. We are going to have to learn to live with more volatility, more macro and geo-political risk and more demand for scarcer resources. As risk managers ensuring the long-term solvency of our businesses, treasurers must bear the ESG prerogative in mind supporting wherever we can the drive to lessen environmental impact within our own spheres of influence.