The COVID-19 crisis is generating liquidity gaps for companies and threatens their survival. The weak consumer demand and ongoing supply chain disruptions are straining the cash and working capital positions of companies that might lead to financial glitches. Despite the economic opening-up, the real economic crisis is still waiting on the front door and will be faced small and midsize companies due to the lack or insufficient support of governments.
Companies have to strengthen their cash position to survive this coming crisis by establishing a plan preserving cash, releasing cash tied up in working capital and take advantage of credit lines with their financial institutions.
As the current crisis has different cash consequences across and within industries, it is important to consider several instruments to face the situation:
- Building a liquidity forecast
The first approach to manage such a situation is a careful planning of liquidity needs to handle covid-19 and the upcoming crisis. The finance department has to adopt a structured approach to manage the liquidity risk and the focus should be on income and payment assumptions. Within the payment assumptions, it is necessary to identify core payments and sales-related payments. However, traditional approaches to forecast liquidity needs like top-down and bottom-up are unlikely to give an insight into the situation. Consequently, supplementing data with an account receivable and account payable analysis as well as an industry analysis is critical. Furthermore, a buffer for the unknown should be set up. Having established a base case, companies must evaluate different scenarios to understand their funding needs in the worst case and establish strategies for this situation. Finally, companies should review funding options with their house bank and other financial institutions.
- Manage Cash Conversion Cycle
The second approach addresses the cash conversion cycle of the company. The financial department measures the key metrics (inventory, account receivable, and account payables ratios) and compares it to the industry norm. Due to the contingency measures, the cash conversion cycle differs between industries: Bricks and mortar businesses had to shut down, food retailers are taking advantage of panic purchases and have seen thus a revenue increase whereas airlines experienced a massive decline. A well-designed working capital management can set free tied capital and help to survive the turbulence economic times. Some measures to manage the working capital are:
– Forecast frequently up to daily basis
– Revision of upcoming capital expenditures
– Extend payment terms and reduce account receivables
– Consider the Supply Chain Finance Mechanism
- Consider Supply Chain Finance Instruments
In the third approach, companies take advantage of Supply Chain Finance Offerings which emerged as a key tool for the working capital management after the subprime crisis. Generally, it distinguishes between three product categories:
Image 1: Supply Chain Finance Products, Source: EURO Advanced Tutorials on Operational Research, 2018
As it is shown on image 1, the supply chain finance products are customized for the cash conversion cycle. Each company should evaluate through a strategic plan and take consultancy by its financial institutions to have a tailor-made plan for its company.
There are several benefits from Supply Chain Finance products for both suppliers and buyers:
|-Improve working capital efficiency (Days Sales Outstanding)|
-Some products are less expensive than other traditional financial products
-Improve supplier relationships
-Off-balance sheet financing
|– Improve working capital efficiency (Days Payable Outstanding|
-Stabilize supply chain
-Innovative new solutions with positive impact on EBIT
-Low risk revenue stream
– Low acquisition cost
– Better risk management due to better access to information
With a clear data and action plan, the company might be better equipped to cope with the crisis rather than catchup with competition. We recommend to take these three approaches to tackle the current situation for small and midsize companies.