As global demand continues to drop for many goods and services, fears of a worldwide slowdown and a “coronavirus recession” loom large over corporate leaders. Chief Financial Officers (CFOs) are scrambling to do sensitivity analyses to understand their profit outlooks and cash needs. Procurement and sourcing teams can play a significant role in reducing supplier spend and improving cash flow by using spend analysis to leverage data in the ERP, contract management, and procure-to-pay systems.
No one in business is more front-and-center than the Chief Financial Officer (CFO). Right now, they’re likely going through in-depth scenario planning to fully understand the cash requirements necessary to maintain your business and deciding what operating changes might be made to optimize cash flow and avoid any layoffs. Together with the CEO, the CFO will work to ensure the company has the cash it needs to operate and survive in this difficult time.
“Cash is King.”
Those were the first words uttered on my first day of business school by Professor David Hawkins in his Financial Planning & Analysis class. While there are many metrics a successful company might highlight (like market share, sales growth, profit margins, or market value) – ultimately, it’s cash flow that determines viability.
Unprecedented government mandates require employees work from home, close restaurants, and restrict global travel – changes that are bound to have serious ripple effects throughout the economy in upcoming months, even perhaps a ‘coronavirus recession.’
CFOs are looking closely at the cash needed to run your business when sales and revenue face coronavirus-related disruption. Since CFOs want to avoid layoffs in any downturn, they’ll want to look at supplier spend first.
Professor Robert Simons created a framework called the “Three Wheels of Profit Planning”, consisting of three “wheels” representing:
- Profit
- Cash Flow
- Return on Equity (ROE)
Profit, Cash Flow, and ROE are all highly interconnected and critical to the success of every business. In times of economic distress, the CFO must examine all the levers for each of these wheels to determine if your business will face a near-term cash flow shortfall.
Step 1: Sales Sensitivity Analysis
The coronavirus recession will immediately impact sales, which leads to a decline in revenue. The CFO must conduct a “sensitivity analysis” test – testing the effect on cash flow if sales and revenue decline by 25%, 50% and 100% over the next three months.
How: Your CRM (Salesforce), Forecasting System (Adaptive Planning, Anaplan), and ERP will house the key data. For companies with longer sales cycles, closely examine pipelines and assume sales cycles will be extended.
Step 2: Operating Expenses Analysis
Operating expenses will not contract as quickly as sales and revenue. Therefore, the CFO must understand your operating expense (or cost base).
- Direct costs or “variable costs” are directly related to the delivery of revenue or production outputs (typically estimated as a percentage of sales).
- Indirect costs are not directly tied to a product or service provided to the customer but are required to support the underlying activities and the overall enterprise. Indirect costs (or indirect spend) can be related to IT, marketing, facilities, travel, office supplies, professional services and nearly every part of the business. It’s critical for the CFO to understand which costs are committed and which are discretionary.
- Salary refers to the cost of employee salaries. Of course, the only way to reduce salary expense is by laying off employees, which is the last option for CFOs when thinking about how to reduce expenses in this ‘coronavirus recession.’
How: Understanding your expenses requires less guesswork than understanding your sales, but it can also be more complex. Your accounting system or ERP will hold the aggregated data, but rarely has the data to make decisions. Your HR or Human Capital Management (HCM) will hold detailed salary data to make trade-offs by position. Supplier data is stored in your ERP, T&E System, P-card data, contract management system, and procure to pay (P2P).
It can be time-consuming and difficult to pull together the right analysis on supplier spend to forecast expenses accurately. Spend analytics or procurement analytics systems like Suplari quickly enable the entire enterprise to make better supplier and spend related decisions.
Spend analytics will allow you to understand what outstanding supplier commitments have been made and what long-term supplier obligations exist. Armed with this information, the CFO can make better decisions about which suppliers can be cut back with the least impact to your business.
Step 3: Calculate Operating Profit
Net Operating Profit After Tax (NOPAT) is the best estimate of the economic health of the business. NOPAT is calculated by subtracting operating expenses and taxes from revenue.
If you aren’t tracking to expected profitability based on your sales sensitivities, you’ll need to go back and look for reductions in operating expenses – either in salaries or in your indirect expenses. This is the hard work where managers need to make trade-offs for the near-term and long-term financial health of the business.
Step 4: Understand Investments
Given the above steps, you’ll have a good sense of what profit looks like under various sensitivity scenarios.
All businesses need to make both operating and capital investments to stay competitive and drive future sales. This is called an investment plan and typically operates on a longer-term time horizon. Operating investments can include sales expansions, R&D, technology, or branding campaigns. Capital investments can include new store expansions or other capital expenditures used to grow the business. Given a near-term decline in the economy or business environment, most investments will be delayed until the CFO sees that the Coronavirus recession is ending.
Step 5: Cash Flow Analysis
The final and perhaps most important analysis is a cash flow analysis.
At its simplest, cash flow equals cash received from customers minus cash paid to suppliers minus cash required to invest in capital expenditures (CAPEX). To stay viable, a business must sell products and services to customers and collect enough cash fast enough to pay out to the suppliers that keep the company operating.
Working capital is the amount of capital needed to run the business calculated as Current Assets (Cash, Accounts Receivable) – Current Liabilities (Accounts Payable, Short-Term Debt). During this downturn in the market, you can assume working capital requirements for your business will increase as customers take longer to pay for goods and services.
These are scary and challenging times for CFOs and businesses everywhere. To get ahead of the Coronavirus recession, companies need the ability to take quick and targeted action based on the right financial analysis on the right data.
Suplari leverages your data to help drive quick action and reduce your spend base. Contact us to schedule a demonstration right away.
