Be upfront with lenders on any disruptions to the cash flow situation. Being transparent carries a lot of weight, especially in risker financial environment. Image Credit: Shutterstock

The extraordinary support packages seen in the most extraordinary of times allowed so many businesses to continue during the pandemic, despite the many constraints inflicted upon them.

Perhaps, this artificially narrowed the gap between the winners and the ones nearly drowning. As we now accelerate away from COVID-19 to face a different set of economic challenges including high and persistent inflation, supply chain disruption and geopolitical tension, we expect to see that gap increase again.

The fear of a credit crunch looms with the central banks across the region recently raising their benchmark borrowing rates after the US Federal Reserve increased its key rate for the sixth time this year to combat inflation. These economic scenarios are challenging and demand we all put liquidity and capital efficiency higher on our business priority lists. And rightly so.

It is vital that companies are appropriately set up from a financing and operational standpoint. Is there sufficient liquidity and will capital structures be able to survive what is expected to be a bumpy ride?

More liquidity is better than less when you believe uncertainty lies ahead, because it’s harder to raise it when you need it, rather than when you don’t. This reinforces the need for preparation and getting ahead rather than reacting at a time when you might not have the broadest range of options available.

So, what can a business do today to prepare and avoid a cash crunch?

* Create visibility: Update your business plan with today’s realities and with a focus on cash and capital efficiency to ensure you have sufficient liquidity to preserve and enhance shareholder value. Build downward scenarios to understand the actions needed if all doesn’t go according to the plan.

* Evaluate financing options today: If the outcome of your business plan and cash flow forecast shows that the ability to service debt as scheduled is at risk, don’t try to sweep it under the rug. Be transparent and have frank conversations with the lenders early to retain their trust. Surprising them with bad news later indicates that you are not fully in control of the situation.

* Measure Return on Capital Employed (RoCE) and cash flow: The EBITDA does not equal cash flow. Particularly when the revenues are growing, working capital will drain some of the cash, if action is not taken to improve the efficiency. RoCE and cash flow will provide a balanced view of the performance that matters the most to the shareholders – maximizing the returns on investment.

* Ensure the incentive structure is aligned. Continuing to reward e.g., sales executives purely based on revenue whilst ignoring the cash component will guarantee that the working capital metrics become quickly irrelevant.

* Define and implement initiatives that will improve your working capital efficiency: Working capital levels are largely a reflection of the quality of the operational processes, and contrary to the common misconception, mostly outside of the CFO’s direct remit. Typically the key levers - e.g., sales and operations planning, procurement process and incentive structures - require cross-department collaboration to define initiatives to reach optimized working capital levels.

Analyze the ratios and their root causes to establish a view of the current state and gather the troops for a workshop to identify the opportunities.

With continuing disruptions, the feeling of uncertainty that many businesses may be feeling is understandable. However, freezing in fear and delaying action is the worst tactic. Instead, every smart business should prepare and be proactive about warding off a cash crunch…