In this crisis, solid cash forecasting is everything. Anyone doubting it should seek an audience with ratings agency, S&P, which in the first two weeks of the crisis hitting Europe, reviewed 20% of its portfolio, downgrading or putting on negative watch or outlook some 75% of the reviewed companies. It seems only those able to explain how they will survive the next stages of the pandemic without liquidity issues will come out of this crisis without any ratings scars.
To offset the difficulties, state help is being offered in many cases, with different countries announcing different proposals (even if not all are ready for distribution). Understandably, no government wants to underwrite already poorly performing businesses or give aid to cash-rich operations. This means that when a company wants to use these lines, it has to build a very strong credit case, explaining prior viability, the financial impact of the pandemic, and the precise amount needed to enable it to trade out of any short- to medium-term difficulty created by the pandemic.
Commonly, cash forecasting is used to project expected cash positions. This knowledge is then built into managing a company’s short-term liabilities. Failure to generate the right figures could spell disaster, especially if lending lifelines cannot be accessed as a result.
For Didier Philouze, MD, Global Head of Debt Advisory, Redbridge Debt & Treasury Advisory, “ongoing and frequent cash flow forecasting in the current environment is at the core of any discussion you may have with the ratings agencies, the markets, lenders, and even states that are offering lending guarantees”.
Every business is affected by the pandemic but not all in the same way when it comes to cash and liquidity positions. At the highest level, obviously companies with large cash buffers and low leverage and debt-servicing costs will be more resilient than those not fitting this financial ideal.
But some sectors are naturally more robust than others in the current situation. Some businesses, such as online retailers and supermarket chains, are clearly benefitting from increased cash flow (indeed, in the UK alone, the week the lockdown began, the major brands saw a 40% surge in demand, with an average rise of 20% across March). Not so the airline, travel and tourism sectors (to name but a few) which are suffering in unprecedented ways due to the almost global lockdown.
That said, even the so-called ‘defensive industries’ (those that are relatively immune to economic fluctuations, such as the supermarkets) that are seeing an enhanced form of ‘business as usual’ are facing new challenges with COVID-19, notes Dino Nicolaides, MD, Head of Treasury Advisory UK&I, Redbridge Debt & Treasury Advisory.
Supermarkets, for example, are having to develop their logistics infrastructures in order to satisfy huge demand, many outlets are seen almost as a frontline service to local communities. These businesses must assess whether increased demand will be sustained long enough to get sufficient return on any infrastructure development costs, or whether post-COVID-19 their expanded logistics will absorb too much cash. It is a cash balancing act that could have troubling consequences if the numbers are wrong.
There are many more sectors which fall between the extremes. Some are strong financially, yet under pressure from lockdown regimes, such as luxury goods, and ‘bricks and mortar’ retail sectors. These may be strong today but almost certainly need contingency planning to mitigate the liquidity risk created by the unknown duration of global lockdown. Accurate forecasting here is also a matter of survival.
No business, it seems, is immune. “Distressed organisations are trying to find emergency liquidity, whereas cash-rich businesses are still having to think ahead and engage with a wide range of ‘what-if’ scenarios as they try to understand and further reinforce their liquidity position,” explains Nicolaides.
It might be imagined that major corporate buyers (those with the large cash buffers and low leverage and debt-servicing costs) rushed to help their key suppliers with supply chain finance solutions, as the widespread effects of the pandemic were realised. But, notes Philouze, many of these businesses – notably in the automotive and aerospace sectors which rely heavily on a vast network of OEMs – have been forced to manage their own survival, ahead of looking at how their core suppliers’ cash flow situations are deteriorating. Even for cash-rich companies then, with revenues depleting, the level of cash burn has been accelerated, he observes.
Of course, those businesses in the defensive, and even middle ground positions, still may have bank lines open to them. Under normal circumstances, these lines of credit would often have gone untouched, retained merely as a back-up resource. “But for businesses that are now very tight on liquidity, we have seen many drawing fully on all the lines available to them.” For some, this is a forward-thinking act.
With a typical revolving credit facility (RCF), a company usually needs to regularly renew its short-term (one to 12 months) drawings under that facility. The ‘representations and warranties’ that it needs to give to its banks to renew what it has already drawn are “usually much lighter” than for new drawings under that facility, explains Philouze. In the current trading environment, where cash flow is so volatile, those reps and warranties will be extremely hard to provide and fulfil and thus it appears that some companies are drawing down now, just to ease the RCF rolling process.
An organisation able to prove to its banks (and even government) that it was, and has remained, strong throughout, by virtue of superior cash flow forecasting, is in a relatively strong position to absorb the impact of COVID-19. To date though, comments Nicolaides, “very few, if any, organisations are proud of their forecasting”.
Often asked how accurate it needs to be, his response is always “as accurate as necessary to support the decisions you are taking on the back of them”. However, not having the right processes in place to create credible forecasts is not uncommon.
Pre-COVID-19, a company may have been cash-rich and liquidity never an issue. Its forecasting was perhaps never seriously used for any decision-making, and in any case it may have had significant headroom in all its funding lines not to warrant concern. But in the short time it has taken COVID-19 to turn the world upside down, cash flow forecasting has become a key tool to understand what, for many, are now existential cash and liquidity needs.
“We have seen some organisations trying to pull together cash flow forecasting processes overnight to try to understand where their business stands, where its cash is, what its needs are, and what lines it needs to negotiate, all in order to survive,” says Nicolaides. “Trying to achieve all this in such a short timeframe is, at best, suboptimal.”
The lesson, particularly with cash flow forecasting, is that it is not possible to know what’s around the corner. Every business needs to have the right forecasting processes in place because at a moment’s notice the need may arise to be able to work through different scenarios and understand their impact on cash and liquidity.
In a crisis, cash flow forecasting becomes an urgent means of assessing liquidity needs. But indirect impacts need to be considered too, warns Nicolaides. As an example, prior to a crisis, a corporate may consider its FX risk to be limited, and consequently its treasury policy indicates no need for hedging.
With COVID-19, intense volatility has been seen across the global financial markets, including FX. With some “unusually large volumes of transactions” having been seen in the FX space in recent weeks, knowing what and how to hedge FX requires sound cash flow forecasting.
“It’s important for corporates to start realising that although in good times, there can be a little relaxation of the procedures, the relevant toolkit must be in readiness.” This understanding is especially poignant as we now know that a crisis can develop in a very short period of time.