The CFO's Role in Recession Planning

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The CFO's Role in Recession Planning

Douglas Maxwell, Chief Financial Officer at American First Finance

Douglas Maxwell, Chief Financial Officer at American First Finance

Rising inflation, coupled with interest rate increases by the Fed, have fueled speculation in the financial press regarding the prospects of an economic recession in the US.  While the CFO cannot prevent a recession, the CFO can play an active role in helping his / her firm in preparing to weather the storm. 
“You may not be able to influence external factors facing your organization, but the CFO can certainly take steps in the right direction by focusing on those elements that the company can control,” says J. Douglas Maxwell, CFO at American First Finance, LLC.  Maxwell offers a few key concepts to keep in mind as companies prepare for the impending economic storm.

Cash is King!

Maximizing cash flows to improve liquidity is essential, particularly in times of rising interest rates and tight credit markets.  Maxwell recommends focusing on shortening the cash conversion cycle.  The cash conversion cycle measures the length of time (in days) that it takes a company to sell its inventory, collect its receivables, and pay its bills.  “Shortening days inventory outstanding and days sales outstanding, while stretching days payable can help improve short-term liquidity.  This may help avoid or reduce the dependency on the need to draw on revolving lines-of-credit in managing an immediate cash crunch.

Controlling Discretionary Spending

A full examination of departmental P&Ls may lead to the discovery of expenses that can be avoided or deferred.  Areas such as marketing and travel & entertainment generally are a source of low-hanging fruit.  Reviewing vendor contracts that are approaching a renewal period may also be an opportunity for savings.  Pay particular attention to contracts with evergreen clauses.  “Some contracts have provisions that result in an automatic rollover for an additional time period unless prior notice is given.  Companies can unknowingly commit themselves to another year’s worth of expense for a product or service they may be no longer using” says Maxwell.  “Even if you decide it is still a valid future expenditure, you migt be able to take advantage of the current economic climate and negotiate more favorable terms, as vendors may seek to retain your business at a lower price rather than risk a cancellation of the current agreement and the loss of the corresponding revenue.”

Scenario Analysis

Having a strong FP&A team to help model various upside / downside events will help the CFO visualize potential impacts to the P&L.  “What happens to the organization if revenues drop 5%?  What if revenues drop 10%?  How will profitability and cash flow be impacted?”  These are the types of questions a CFO needs to be prepared to answer.  Additionally, having a clear understanding of what cost components are fixed versus variable is important.  “Companies with a higher fixed cost structure have a more difficult time adjusting to downturns in revenue” says Maxwell.  In these cases, cash inflows are reduced due to lower revenue, but cash outflows remain constant due to the fixed nature of the company’s operating expenses.  This can lead to a significant burn down rate of existing cash balances, putting further pressure on the organization.

Debt Covenants

Performing scenario analysis as described above should also include consideration of any debt covenants that the firm is obligated to with its lenders. “Maintaining strong communication channels with lenders is critical in today’s environment” says Maxwell.  “Demonstrating a command of your financial projections and the ability to take swift action to course correct if conditions deteriorate helps to instill confidence in your creditors, helping to ensure that the firm maintains its access to capital.”

While the CFO cannot prevent a recession, effective implementation of the strategies articulated above can assist in helping the firm navigate successfully through challenging economic times.  

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