Forecasting during a pandemic
How do you plan for uncertainty when every assumption is subject to change?
2020 has shown business owners that now, more than ever, they need to have a plan in place to manage cash flow and keep their businesses going during uncertain times.
Even if the business is not directly impacted it's likely that customers, the supply chain, and workforces will be affected to some extent.
With that in mind and the open-ended nature of COVID-19 pandemic, what do you need to be looking at now to prepare for the months ahead?
Understand where you stand now
Businesses fail (or fail to thrive) for many reasons, but the precursor is often a failure to understand what is occurring and what to monitor. Strategically, managers need to be on top of their numbers to identify and manage problems before they get out of hand. If you do not know what the key drivers of your business are - the things that make the difference between doing well and going under - then it's time to find out.
Understanding your cost structure
Do you know what your real cost of doing business is?
Your breakeven point is the level of sales activity where your business is neither making a profit or a loss. Calculate your breakeven point by dividing your fixed expenses by your gross profit margin. This figure represents the level of sales income you need to breakeven.
Your breakeven point is crucial particularly when supply chains are impacted
Understanding your supply chain is important. Risk manage and plan for changing conditions. For example:
- What is your business's ability to manage a surge in demand?
- Do you have a small supply base?
- What would happen if your primary supplier went into bankruptcy?
- Do you have a good flow of information across your supply chain or is there a lack of transparency and knowledge, do transport problems risk your ability to supply?
A critical number here is the breakeven point in your business. Not only will your breakeven point assist you to monitor business performance, it's critical when deciding whether or not to offer a discount to drive sales activity as the pandemic continues.
If your breakeven point is well below your current operating level then you have a good buffer in your profits to manage growth, invest in further capital opportunities, and to protect yourself against further downturns in operating performance. And before you say "I know that," ask yourself how many people actually put this theory into practice. Even some of the largest businesses have been caught out on this one and tie up valuable resources in unprofitable projects and products.
Putting up prices during down times is not an act of social betrayal. If your prices have increased you should flow these through unless you are comfortable making less for the same amount of effort, or you are in an industry that is so price sensitive you have no choice but to follow the lead of larger businesses. Discounting creates a leverage impact on profits. By discounting you are giving away some or all of your profits.
The key is to understand the impact and just how far you can go.
For example, a business with a 30% gross profit margin that offers a 25% discount (certainly nothing unusual about that in today's market) needs a 500% increase in sales volume just to maintain the same position – and, in almost all cases, that's just not going to happen. The result generally is that the business trades below its breakeven point and generates a loss. You can only do that for a limited amount of time (and some of your larger competitors might be engaging in a discounting war with you in an attempt to bury you once and for all).
If your business needs cash and needs it quickly, discounting might be the only way to shift stock but understand the implications.
Plan, review and adjust
Your budget should be the best estimate of what is likely to occur based on current knowledge. To manage change, you can plan scenarios where your budget forms the baseline, but you also forecast best and worst case scenarios based on potential risks and their likelihood (for example, the impact of another lockdown).
Or, the simplest method is to use your budget as a baseline and regularly review and adjust depending on current conditions.
The greatest risk to profit is unlikely to come from your cost structure-it is more likely to be revenue volatility. Keep your eye on your cost structure and make sensible cuts where appropriate, but in your search for savings, don't remove the essential revenue generating capacity that you need.
Cashflow will always be king
While a lack of profit will eventually erode your business, not enough cash can kill it stone dead. Businesses will fail because they don't manage their cash position.
Plan, track and measure your cashflow. This not only means closely monitoring your debtor collections and inventory but also running a rolling three month cashflow position. This should provide an early warning of brewing problems.
Manage your debt levels carefully-your bank is likely to. While there is nothing wrong with debt, it is likely that the banks will be closely watching customer accounts. Where you have loan facilities in place make sure that you understand the loan terms and any debt covenants that you have entered into. These covenants could include regular reporting to the bank, debtor and working capital ratios, or debt to equity ratios. Where the banks may have been more relaxed about these in the past, it's unlikely that will be the case going forward.
If you believe that you need additional funding, talk to your bank early and don't wait until the last minute. You'll need to present your case on why you need it, how much, for how long and when it will be repaid.
Cashflows, operating budgets, cost control and debt management all need to be part of your business management. The more in control you are the lower your risk position.
Understand the external environment
COVID-19 has implications beyond the economy, as consumer behaviour is shifting and businesses are having to adapt in response.
While comparisons are made to the 2008 Global Financial Crisis and the recessions of the 1980s and 1990s, the reality is, we have no case study or rule book for the post pandemic road to recovery as this is not an economic event. The pandemic has pulled the economy up short by curtailing both supply and demand; businesses are not operating at capacity and fewer people are working.
The Federal Budget is scheduled for release on 6 October and pundits anticipate that the Government will focus heavily on job creation projects, many of which will be likely be in infrastructure. The expectation is that this will have a flow through effect to the broader economy.
When it comes to demand, there is no instant fix. The RBA suggests the decline in GDP in the first half of 2020 is around 7% and the contraction in hours worked around 10%. The economic impact of the restrictions in Melbourne extend well beyond Victoria and are impacting more generally on consumer sentiment.
But it is not all bad news with confidence lifting on early signs that revenue is no longer declining for the majority of Australian businesses. The latest ABS data on the impact of COVID-19 shows fewer businesses reported a decline in revenue in August (41%) compared to July (46%), and fewer still expect a decline in September (28%).
However, 35% of businesses expect it to be "difficult or very difficult" to meet financial commitments over the next three months, with small and medium businesses almost twice as likely as large businesses to fall into this category.
Understandably, the response to this question is heavily weighted towards those operating under Government required restrictions and lockdowns.
The RBA is working with three scenarios for Australia's economic outlook: a baseline, upside and downside scenario. In the baseline scenario, conditions improve in the second half of 2020 and slowly improve over 2021 and 2022 but fall short of returning to pre COVID forecasts with Victoria's lockdown not materially extended and Australia's international borders remaining closed until mid 2021. The upside scenario saw no extension of the Melbourne lockdown, and further easing of Government restrictions nationally, which in turn bolster consumer confidence, encouraging spending and the reversal of GDP decline over 2020-21. The downside scenario envisages a global resurgence in infections with Australia facing periodic outbreaks and rolling lockdowns. The RBA notes that the downside scenario has a sharper fall than the increase of the upside scenario because of the damage to consumer confidence of further lockdowns.
Business investment is also expected to be relatively flat with the ABS survey showing that 37% of those surveyed had no actual or planned expenditure. Of those that are spending, IT hardware and software, and equipment and machinery topped the list. The instant asset write-off is helping to stimulate business investment in the small and medium business sector. In general, large businesses are paying down debt rather than spending and small and medium businesses have not sought to extend debt to fund investment.
Seek advice early
We can help give you insight into the performance of your business. Contact us to find out how we can give you the intelligence you need.
This article is provided for information purposes only and correct at the time of publication. It should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.