Author: Scott Richards
In 2002, three men in an SUV set off bombs at the Paradise Hotel in Mombasa, Kenya. Almost simultaneously missiles were fired at a tourist charter plane.
These acts killed 13 people and had a significant impact on Kenya for the next couple of years. In 2003, western countries, including the USA and UK, advised against non-essential travel to Kenya. Kenya’s economy was devastated – especially tourism. Tourism alone was worth close to 10% of GDP.
This event also impacted the international school for missionary children where I worked as Director of Finance. Over the summer break, a number of families did not return. Our revenue dropped overnight. As a result, I learned a major lesson in dealing with a sudden financial impact and the importance of cash flow. It reinforced that the decisions you make today will impact the business and cash flow, not only today but also for many years to come. Your most valuable resource during a crisis is wisdom.
Wisdom is needed to make those critical decisions about cash flow. During a recession or crisis, customers and cash flow are vital. Use wisdom to make cash flow management your competitive advantage.
Focus on Decision Making
Your company’s performance during and after a crisis depends on the decisions you make. Not having enough information can lead to poor decisions. However, poor decisions can also result from gathering too much information.
Colin Powell advises that, when making a tough decision, we should have between 40 and 70 per cent of the required information. Leaders feel pressured into making decisions quickly and may do so without enough information and understanding the cash flow impacts.
The opposite is wanting too much information to make a decision. With the environment changing quickly, don’t wait until you have all the information or get stuck in paralysis by analysis. When facing the financial crisis in Kenya, I prepared my cash flow forecasts on a piece of paper. I needed to keep it simple. A one-page summary that I easily understood.
Know Your Critical Numbers
Every business has a few critical numbers that they must get right. With information overload today, we can overlook these critical numbers and focus on things that are urgent but not important. The formula that I use to bring focus is the break-even sales formula. Break-even sales are the dollar amount of sales when the business earns a profit of zero (0). I love this formula because it is versatile; you can use it for high-level analysis or detailed analysis of activities.
Cash flow is more than just profit. You must know the cash flow drivers outside of profit that needs to be managed tightly during a crisis. The typical cash flow drivers of concern are accounts receivable, inventory and debt. Businesses having too much stock is a regular issue. Holding onto inventory is like taking fuel out of your car and putting it in a drum out the back.
A Balanced Approach
The businesses that do well during and after a recession find the balance between cost-cutting and growth. Companies do poorly if they focus too much on cutting costs or are too aggressive on growth. The default position for many businesses is to use layoffs to cut costs quickly. However, research shows this rarely works in the long term. Reducing staff affects morale, loss of industry knowledge, and it is costly to rehire when the economy starts to grow.
Similarly, being aggressive in growth leads to wrong decisions. The focus on only growth can cause an optimism that denies the reality of the situation and can ignore early warning signs such as customer budget cuts.
Use a Phased Approach
Experience from past disaster recoveries revealed that a phased approach worked best for small businesses. We promote using a four-phase approach:
2. Intensive Care (ICU)
Below are the action steps for the first two phases.
Phase 1 – The Triage Plan
During a medical emergency, the first step is to stop the bleeding. We should do the same for our business. Identify the areas where you are bleeding money, that can be addressed immediately.
Firstly, look at your costs. Print out the latest monthly bank statements. Identify the costs that add no value to your customers or business processes. Eliminate these expenses. I like to start with direct debits. To help, I ask myself, ‘What is the business reason for this expense?’
Look at your accounts receivable and inventory. Identify any potential issues in recovering money or selling inventory. For example, you may need to offer new payment options.
Review your debt repayments and the cost of having the debt. Identify ways to give yourself some breathing room to make a more informed decision.
Prepare a simple cash flow forecast for the next few weeks or month.
Phase 2 – The ICU Plan
This phase is where we work on surviving, stabilising and planning for rehabilitation. During this time communication is vital. Keep communicating with your customers, employees and suppliers. All communication should be clear and honest.
The businesses that do well build a strong balance sheet. This creates flexibility and provides a safety buffer. The successful companies during the GFC reduced debt by shedding non-core assets. Be sure you know how much debt your business can handle.
Prepare a cash flow plan. I prefer to use scenario planning instead of one cash flow plan. This way, I can stress test the forecast and develop trigger points. For example, if sales drop by 30%, we will stop a specific activity to reduce costs.
During this stage, be working on your plans for the Rehabilitation and Recovery phases. Your recovery is often dependent on external factors and how effectively you manage your cash flow.
The major lesson I learned during my time in Kenya is that effective cash flow management can be your competitive advantage. If you are able to get through the crisis, opportunities will open up that would not have been available before the crisis. Four years after the school’s crisis, we were able to invest in infrastructure that opened the door to a new market and ensured the future financial viability of the school.
Photo credit: Shutterstock.com
About Scott Richards
Scott Richards has been helping businesses achieve their financial and cultural goals for over 20 years.
He is a partner at Beyond the Numbers, where he assists businesses with budgeting, forecasting and scenario planning including cash flow management.