The Cfo's Role In Recession Planning

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Rising inflation, coupled with interest rate increases by the Fed, has fueled speculation in the financial press regarding the prospects of an economic recession in the US. While the CFO cannot prevent a recession, the CFO can play an active role in helping his/her firm prepare to weather the storm. “You may not be able to influence external factors facing your organization, but the CFO can certainly take steps in the right direction by focusing on those elements that the company can control,” says J. Douglas Maxwell, CFO at American First Finance, LLC. Maxwell offers key concepts to keep in mind as companies prepare for the impending economic storm.

Cash is King!

Maximizing cash flows to improve liquidity is essential, particularly in rising interest rates and tight credit markets. Maxwell recommends focusing on shortening the cash conversion cycle. The cash conversion cycle measures the time (in days) it takes a company to sell its inventory, collect its receivables, and pay its bills. “Shortening days inventory outstanding and days sales outstanding while stretching days payable can help improve short-term liquidity. This may help avoid or reduce the dependency on the need to draw on revolving lines of credit in managing an immediate cash crunch.

Controlling Discretionary Spending

A full examination of departmental P&Ls may lead to discovering expenses that can be avoided or deferred. Areas such as marketing and, travel & entertainment generally are a source of low-hanging fruit. Reviewing vendor contracts approaching a renewal period may also be an opportunity for savings. Pay particular attention to contracts with evergreen clauses. “Some contracts have provisions resulting in an automatic rollover for an additional period unless prior notice is given. Companies can unknowingly commit themselves to another year’s worth of expense for a product or service they may no longer use,” says Maxwell. “Even if you decide it is still a valid, future expenditure, you might be able to take advantage of the current economic climate and negotiate more favorable terms, as vendors may seek to retain your business at a lower price rather than risk a cancellation of the current agreement and the loss of the corresponding revenue.”

“ You may not be able to influence external factors facing your organization, but the CFO can certainly take steps in the right direction by focusing on those elements the company can control ”

Scenario Analysis

Having a solid FP&A team to help model various upside/downside events will help the CFO visualize potential impacts to the P&L. “What happens to the organization if revenues drop 5%? What if revenues drop 10%? How will profitability and cash flow be impacted?” A CFO needs to be prepared to answer these types of questions.

Additionally, having a clear understanding of what cost components are fixed versus variable is essential. “Companies with a higher fixed cost structure have a more difficult time adjusting to downturns in revenue,” says Maxwell. In these cases, cash inf lows are reduced due to lower revenue, but cash outf lows remain constant due to the fixed nature of the company’s operating expenses. This can lead to an effective burndown rate of existing cash balances, putting further pressure on the organization.

Debt Covenants

Performing scenario analysis as described above should also include consideration of any debt covenants that the firm is obligated to with its lenders. “Maintaining strong communication channels with lenders is critical in today’s environment,” says Maxwell. “Demonstrating a command of your financial projections and the ability to take swift action to correct if conditions deteriorate helps to instill confidence in your creditors, helping to ensure that the firm maintains its access to capital.”

While the CFO cannot prevent a recession, effective implementation of the strategies articulated above can assist in helping the firm navigate successfully through challenging economic times.