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Taken with permission from December 18th’s 2019 Apliqo blog post
Be realistic: business downturns are inevitable
“In FP&A, the first thing we have to do is recognize that economic cycles are cyclical,” says Jack.
That means your company is going to face business and economic downturns, despite what some investment communities might want you to think.
And as a CFO, it’s your role to acknowledge the challenges and potential downturns facing your business, plan for them, and minimize their impact on the company.
To do this, you should:
- Provide context during economic upturns and dampen any kind of irrational exuberance.
- Construct business models and practices that take into account the inevitable nature of downturns.
- Develop effective analysis.
- Prepare your company for a downturn during the good times.
Know what NOT to do during a business downturn
Businesses suddenly facing an unexpected downturn tend to hit the brakes and take drastic short-term actions that only cause them more problems in the long run, including across-the-board cuts to discretionary spending, human capital, and investments.
If your business is hit with a downturn, you first need to ditch this “bunker mentality” and instead focus on putting in place a robust planning model that helps you better prepare for other inevitable downturns further down the road.
Here’s how to do that —
1- Understand the value in planning
US President Eisenhower once said that “plans are useless, but planning is indispensable.” And in FP&A, there’s a lot that we can learn from that.
“We know that the future is going to be different than we project, and so the value really lies in the critical thinking and discussion that goes into planning rather than the plans themselves,” says Jack.
When your business eventually faces a downturn, it’ll be all the work and thinking that went into your planning procedures that really helps your business, rather than the individual documents you and your team put together.
2- Understand the value in planning
“There’s been a lot of discussion over recent years about driver-based planning,” says Jack. This involves focusing your plans on the operations that drive about 80% of your business.
For most businesses, a lot of this planning will come down to running a comprehensive analysis of revenue and margins. This should cover pricing, product life cycles, new product launches, currency fluctuations, and well as macroeconomic factors (like GDP, interest rates, public policy, demographics, and more).
“Interestingly enough, this is also an area where finance usually spends the least amount of time,” says Jack.
3- Run comprehensive scenario analysis
“We know that the future is going to be different than we expect it to be, and having a single-point plan really ignores this uncertainty,” says Jack. That’s exactly why it’s so important to incorporate comprehensive scenario planning into your finance practices.
To do this, it can help to develop a primary base-case projection, identify and modify the key assumptions leveraging this projection, and then develop different potential scenarios facing the company.
Your team should then create an action plan for each scenario, which should:
- Describe the event and the probability of it occurring.
- Highlight its impact on the company.
- List the leading indicators of the event.
- Highlight a clear trigger event.
- Clearly outline management responses you’ll take prior to, at the time of, and after the trigger event.
4- Embrace rolling forecasts
Rolling forecasts always look 12-24 months ahead and take into account both the company’s key business drivers and key assumptions, offering a comprehensive overview of the company’s performance.
For a closer look at Rolling Forecasts and how they can revolutionize your planning processes, check out our summary of Jack’s webinar on Budgeting and Planning Best Practices.
5- Thoroughly analyze your costs
“One of the best practices for all businesses is to be really rigorous when looking at costs, even during the good times, because this is where there’s always an inevitable growth in spending,” says Jack.
A solid cost analysis should involve:
- Pruning away “bleeders and leakers.” This includes product lines, investments, or customers that are costing your business money.
- Focusing on “big rocks.” Not all costs are created equal, and you should shift your focus to the costs that are the most variable and have the biggest impact on your business.
- Zero-based budgeting to justify expenses.
- Activity-based budgeting.
6- Cash is King!
“Cash flow is a critical element in preparing your company for an inevitable downturn,” says Jack, and one of the best things you can do to help your business prepare for the worst is to build a cash reserve.
To do this, you need to go above and beyond the classic Cash Flow Statement and use cash projections that include:
- A Cash Forecast. Think of this as a checkbook outlining the company’s main inflows and outflows.
- Cash and Working Capital Projections. This should focus primarily on the 2 main drivers of cash flows; collections from customers and payments to vendors.
- Root-Cause analysis for both receivables and inventory.
7- Use downturns as a platform for change
Business downturns can teach us one very valuable lesson; we can’t predict the future. What we can do, however, is revamp our business models to be more agile and flexible. Jack highlights 4 key components for a more agile and adaptable business model:
- Preparation: Hiring agile employees, recognizing and accepting uncertainty, and building robust planning models with all the components mentioned above.
- Vision: Using business intelligence and Rolling Forecasts to craft an open external vision that focuses on present and future leading indicators and key trigger events.
- Recognition: Managing performance with clear KPIs, comprehensive dashboards, and an experienced and versatile team.
- Response: Re-deploying resources, comprehensive cost and cash flow analysis, and sophisticated scenario action plans.
Stay better prepared for the worst
Yes, business downturns are inevitable. But with the right planning model in place, you and your team can help your business prepare for these downturns properly and minimize their impact.