As most of us begin a new financial year (those with 31st March balance dates), we typically would also look to review our budgets or cashflow forecasts for the year ahead and set some new targets. We might even reset our strategic direction, and better yet, we would align our strategic direction and our cashflow forecast to ensure that the two are in unison.
However, the way that companies managed working capital and short term cashflow changed considerably during the last two years as we tackled the Covid pandemic. When Covid first hit our shores, many businesses took rapid action to ensure they had sufficient access to cash for survival. For most of us, this meant drawing down on existing credit facilities, requesting support from our funding partners, and even taking advantage of government stimulus packages, such as the wage subsidy. In fact, a lot of businesses reported better than expected cash flow. However now businesses are beginning to face a cash flow pinch where existing funding facilities are exhausted, additional funding is unlikely, cost of funding has increased, general business costs have increased, and the government lolly scramble packaged as financial support is no longer available. Essentially over the last two years we have managed to navigate through a global health pandemic, now only to be greeted by a likely economic pandemic.
Think about these factors for a moment. As business owners we are facing the following headwinds: rising cost of labour (the minimum wage goes up to $21.20 per hour from 1st April 2022 and this has a trickle up effect for all other staff); the shortage of labour supply; the risk of our existing labour leaving to take up roles overseas now that borders are slowly opening up again; the rising cost of materials, goods and services; challenges and delays with supply chain still impacting businesses again this year; increasing compliance requirements; and remote workforces becoming the norm for some businesses. These factors create threats to business, but also opportunities if you can harness them.
So how do we set an accurate direction and forecast for the year ahead, after just surviving two years of having the spectre of the Covid pandemic infiltrate our businesses and forever change the way we do business, and indeed our lives? What should be the basis for our forecasts for the year ahead? Should we go back to pre-pandemic assumptions and trading expectations? Can we continue with our current level of trading?
Some of us may be tempted to cut product size, quality, and benefits to maintain existing prices to meet the market, while some of us will be able to increase prices, and in some instances, this could be on the back of several recent price increases. In addition, we may feel that we can no longer pursue plans to expand operations and grow our business, or worse, even keep the workers that we have based on current trading performance given we are probably asking employees to do more with less. These are some of the questions that we need to address as we look to the year ahead.
To assist with managing these challenges, as business owners, data is often the best way to meet these issues head on. It’s critical to understand what the metrics say about your day-to-day operations, what trends might they provide, and what warning signs could they alert you to. When thinking about these metrics there are, in my view, three key areas to consider when you are preparing your forecast and strategic direction for the year ahead. They are:
- Know your break-even point: Now more than ever, this is one of the most critical calculations that businesses should be completing, and you should know this in dollars of revenue and volume of units to be sold. It’s vital to understand what measures can be taken to reduce costs, while not sacrificing future growth opportunities. What costs can you cut and what is your safety margin for your break-even? What costs are variable vs fixed? How sensitive is your break-even with a fluctuation to the NZD exchange or interest rates?
- Cash is king: As the saying goes, profit is like food and cash is like oxygen; we can survive without some food for a while, but we cannot survive long without oxygen. What is your cash flow position at present? Do you know your cash burn rate? What is your cash headroom (the length of time your cash will last, assuming no further revenue, based on your current facilities less you committed to costs in the coming months)? Can you access a war or treasure chest
of cash? You need to know at what point your business becomes cashflow negative. If you are forecasting to lose cash, then you need to reconsider strategies to prevent this potential business death spiral. Having strong cashflow allows organisations time to make planned decisions and to control those decisions. Cashflow management, including diligent forecasting is a must-do. Remember, in growing businesses that experience high sales growth, there is often declining cashflow; that is, it costs cash to grow.
- Balance sheet strength: Reviewing your balance sheet has never been more important than now. By managing your balance sheet, you can unlock cash from working capital (debtors & stock/WIP). In the coming months it’s anticipated that a number of businesses could fail, so debtor collection needs to be at the forefront. Sadly, more businesses fail coming out of recessionary times, than going into them. That is because during the period of recession, we will typically use up any and all of our cash reserves to survive, meaning that when we are finally in a position to trade again, we have very little cash funding to support further investment into our working capital, such as stock or employees. Currently stock-based businesses, if they can afford to, are accumulating additional stock items due to the delays with shipping and supply chain issues. This strategy for many has been a key to the success of business trading during the pandemic, that is, if you have stock (so long as it’s good stock) you have been able to sell it with strong demand from customers. Managing this tightrope strategy comes at a cost however, as holding additional stock sucks up cashflow and can have a major impact on your working capital, so you need to balance the need for stock vs future cash flow requirements.
Typically, there are three things that businesses can use their net profit after tax for: reinvest in the business; pay down debt; or pay a return to the shareholders (i.e. a dividend). So where will your focus be?
The humble cashflow forecast has never been so vital, so leaving this plan to chance is a dangerous game to play. Instead, identify your current financial position, understand the resources available to you, develop a clear plan, and then review and adjust that plan as time goes by.