Reposted with permission by Squar Milner
It is no secret that the COVID-19 pandemic has ushered in a host of challenges for manufacturers & distributors throughout the United States. Like many businesses throughout the country, manufacturers must overcome severe operational and economic changes to financially survive the COVID-19 crisis. In fact, a survey conducted by the National Association of Manufacturers (NAM) revealed that 80% of manufacturers expect the pandemic to have a financial impact on their business.
As those in the M&D industry share concerns about operations, future periods and liquidity and capital resources, there are business strategies available to help protect businesses from negative impacts. To better position themselves for the present, the short term and the long term, it is critical that business leaders institute a cash flow culture.
Establish effective cash management strategies
As you build an effective cash flow culture during these unprecedented times, you have to start with cash management. Cash is king, even during a worldwide health crisis. Now is the time to implement strategic cash management processes to better understand your business’s cash position.
1. Regular cash projections
A short-term cash flow forecast considers the cash you have, the cash you expect to receive and the cash you expect to pay out of your business over a certain period of time, typically 13 weeks. Fundamentally, it provides visibility of your future cash position and enables you to proactively take action to get through a liquidity crunch. It allows you to assess the cash coming into and going out of your bank account and provides a clearer picture of your cash position in a given week. It is a must in the current COVID-19 environment.
2. Model scenarios
Modeling scenarios for how different events may unfold and the associated cash impact is important not only for management but also for external stakeholders such as landlords, lenders and others. Having readily available data on the implications of critical events provides management with additional time to think through decisions while avoiding potential surprises. Transparency – both internally and externally – is key. As various avenues are pursued it’s important to ask “what if?” A well-built cash flow model allows you to understand the impact of certain changes or circumstances for your business. Consider coming up with at least three scenarios – worst case, neutral and best case. Include sensitivity analysis in your models: incorporate potential changes in forecast, delayed receivables, price changes, renegotiated vendor terms, potential asset disposals, loan funding, staffing changes, PPP loan forgiveness, etc.
3. Rolling budget
The budgets that many businesses established at the start of 2020 have quickly become obsolete due to the unforeseen impacts of COVID-19. With many unknowns, it has become difficult to rely on a single, static annual budget. Instead, budgeting during a pandemic requires companies to become more flexible – in other words, a rolling budget may make more sense given the volatility and uncertainty of our current economic environment. Unlike traditional budgets that set a financial plan for the entire fiscal year, rolling forecasts allow for revision on a monthly or quarterly basis, depending on market fluctuations.
4. Communicate with external parties
Evaluating and preparing for potential supply chain disruptions is a must in the current environment. Keep in contact with your key suppliers and develop a Plan B if your supplier is unable to fulfill an order effectively/on time.
5. Variable over fixed costs
In times of uncertainty, you may consider converting fixed costs for variable costs wherever you can to preserve your core business while increasing your financial flexibility. One way to raise cash is selling assets and leasing them back. You may also want to consider expanding your use of practices such as contract manufacturing, transportation fleet leasing, and third-party warehousing. This may be important to longer-term cash flow management, depending on how long COVID-19 disrupts demand and supply chains.
6. Alternative & external cash sources
When you are in a tight cash situation, you should try to identify alternative sources of cash. For example, over the last several months, small and mid-size businesses had access to the Paycheck Protection Program (PPP) which offered forgivable loans to help cover payroll costs and utilities. While the deadline for applying for a PPP loan ended on August 8, 2020, you should explore other loan options available to you and your business.
Some alternative avenues to consider include deferring payments and discussing with your insurance broker your business interruption insurance and potentially filing a claim under it. Now is also the time to consider strategic growth sources, like e-commerce. Throughout much of the pandemic, we have witnessed a number of businesses transition to digital platforms to facilitate sales and preserve and grow their customer base.
Contain your costs
As you establish cash management practices, it is equally important to execute cash containment measures as well. In doing so, it is important to get back to the basics:
1. Set caps on spending
Establish limits on spending for both operational and capital expenditures. With your cash flow forecasts in hand, you should determine which expenses are truly necessary for the near term. What capital investments can you postpone until the situation improves? What capital investments should be reconsidered?
2. Freeze hiring
Reducing your variable costs is often a quick way to immediately reduce your cash outflows. One typical variable cost reduction is the imposition of a hiring freeze. Raising your costs by bringing on new employees or contractors is the opposite of cost containment in these situations. You may also look for opportunities to reduce contract labor and redistribute work to your permanent workforce.
3. Eliminate unnecessary spending
Remember the Pareto principle? Generally 80% of outcomes (or outputs) result from 20% of all causes (or inputs) for any given event. In business, you can use the 80-20 rule to identify inputs that are potentially the most productive and make them a priority. For example, once you identify factors that are critical to your business’s success, you should give those factors the most focus. This rule becomes even more critical in the midst of a severe economic downturn. Reevaluate your costs and KPIs and determine what is the most vital for your success. Also keep in mind the key customers representing the greatest share of your revenue.
4. Prioritize suppliers
As a manufacturer or distributor, you work with a number of different suppliers. Whether its raw material suppliers or co-packing partners, you are reliant on those around you to help keep your business operating. In these times, make an effort to prioritize suppliers, especially those that provide the greatest benefit to your organization. Communicate early and often with your suppliers to understand their situation, as they are likely impacted by supply chain disruption and difficult economic circumstances as well.
5. Renegotiate contracts
One strategy for cost containment is to renegotiate contracts with vendors and external stakeholders. For example, you may try to renegotiate your rent with your landlord – at least for the short term. You could also work with suppliers to delay or extend payments. In order to preserve the relationship, however, you should communicate and establish an agreement that both parties can live with. In deferring payments, be aware of potential credit rating implications.
6. Make payroll adjustments
Business owners must perform a balancing act to support employees while sustaining business operations. However, reducing your payroll obligations is one of the most effective cost saving measures. While this may be a last resort, it’s important to understand how these adjustments can impact your business. Both layoffs and furloughs have high potential for cost savings, as does reducing select employees’ base pay by a set percentage. If it comes down to layoffs, furloughs, or pay reductions do your best to support your employees – remember they are going through this pandemic too. Inform them about unemployment claims and other options available to them.
Get management to buy-in
As with any cultural shift, embedding a cash management culture within your organization requires management to get onboard. To succeed at this, define your objectives up front, assign responsibility to people across the organization and track progress using monthly cash flow metrics.
To encourage adoption, it’s imperative to establish, communicate and implement standard policies across the organization. Cash management policies should focus on budgeting, forecasting and financing and indicate how to handle day-to-day activities such as collections, procurement/ordering and payment.
Keep in mind, too, that cash flow management is not just a finance issue; it’s an operational one. All departments – from sales to marketing, procurement and production to finance and treasury – must coordinate for optimal results.
How can Squar Milner help?
As we continue to navigate the challenges of COVID-19, your Squar Milner team is here to help. Our dedicated Manufacturing & Distribution industry professionals have the expertise and background to understand the complex challenges unique to manufacturers & distributors. We can work with you to develop strategies tailored to your company to help keep your business on the right track.
About the Author
Larisa Rapoport, CPA, MBA, CGMA, is a partner with Squar Milner LLP (“Squar Milner”), a full-service accounting and business advisory firm with a recognized expertise serving middle-market companies. Squar Milner holds the distinction of being one of the nation’s 50 largest public accounting firms as well as one of the largest PCAOB registered independent accounting and advisory service firms on the West Coast, with offices throughout California and the Cayman Islands. Our experience covers both the public and private sectors including publicly traded companies, closely held businesses, and specializing in manufacturers among other industries. She can be reached at firstname.lastname@example.org.