Financial Risks in a COVID-19 World

The business world has changed dramatically and perhaps forever as a result of the coronavirus pandemic. Even with the various financial incentives available in the government’s stimulus package, survival has become the primary focus. ASIC have identified the top five reasons businesses fail – the first being a poor strategy, the other four all relate to the financial management of the business. Given no business strategy could cope with what we are currently experiencing – let’s consider the other four (in order of importance).

1.    Lack of cash-flow and/or high cash use – not enough liquidity

It is no surprise the Qantas share price jumped up recently upon an announcement that they had secured access to over $1bn in standby credit. Sales is vanity, profit is sanity, but cash is reality! But you don’t need to borrow to improve cash flow: – collecting what is owed, deferring what you owe, reducing inventory, outsourcing, debtor financing, capital injections, selling surplus assets and leasing rather than buying are all options to be considered

2.    Poor financial controls – inadequate financial management

When Alice in wonderland came to a fork in the road and did not know which one to take she asked the Cheshire cat which one to take. The cat asked, “Where are you wanting to go?” Alice replied, “I don’t know”… “then it doesn’t matter which road you take!” said the Cheshire Cat. Do you have a cashflow and profit budget for the next six months, perhaps on a weekly basis? Then be prepared to monitor it daily / weekly. If not, you may be planning to fail.

3.    Under capitalisation – too highly geared

As a general rule of thumb, businesses should borrow between 40% and 60% of their assets from third parties, with the balance funded by the owners. In these extraordinary times perhaps the ratios can go a little higher for the short term. This is why it is important to pay down debt when trading is strong, so you can draw back debt when times are tough.

4.    Trading losses – a lack of profit

Traditionally profit is generated by increasing revenue and / or reducing costs. In our world today not many businesses have the option of increasing revenue, so the focus turns to reducing costs by improving efficiencies. In a broad sense you can do this by improving the relationship between outputs and inputs:

  • More outputs with less inputs. For example – streamlining processes. The government is coping with the influx of unemployed at Centrelink by directing them online and waiving much of the red tape in apply for benefits.
  • Same outputs with less inputs. For example – reducing wages. Many businesses are asking people to take a pay cut to avoid the need for lay offs.
  • Less outputs with LESS inputs. For example – working a shortened week. If business volumes are now 70%, then dropping back to a 3-day week (60%) will improve profits.
  • MORE outputs with more inputs. For example – invest money to save money. The demand for headsets is indicative of a shift to investment remote access technologies to provide more time for value adding tasks.
  • Same output with less inputs. For example – cutting any costs not essential (in the short term). Some mine sites stretch out maintenance schedules on plant when commodity prices fall.

Identify your top three costs. Reflect on these five approaches, take a blank sheet of paper and build a budget from the ground up (not using what you have previously spent on this cost). Challenge your assumptions along the way. You may be surprised at the result.

Doug Watson
Financial Acumen & Strategy Specialist

Doug is a highly experienced Financial Acumen & Strategy facilitator based out of Perth.  If you would like to learn more about Doug and his background please visit this link.