As a typical “black swan” event, COVID-19 took the world by complete surprise. This newly identified coronavirus was first seen in Wuhan, the capital of Hubei province in central China, on December 31, 2019. As we enter April 2020, the virus has infected over 700,000 people, and led to more than 30,000 deaths.
More importantly, more than 75 countries are now reporting positive cases of COVID-19 as the virus spreads globally, impacting communities, ecosystems, and supply chains far beyond China.
The focus of most businesses is now on protecting employees, understanding the risks to their business, and managing the supply chain disruptions caused by the efforts to contain the spread of COVID-19.
The full impact of the COVID-19 pandemic on businesses and supply chains is still unknown. However, one thing is certain: this event will have global economic and financial ramifications that will be felt throughout global supply chains, from raw materials to finished products.
One of our recommendations for companies that have business relationships and supply chain flows to and/or from China and other impacted geographies is to focus on cash flow during this COVID-19 outbreak. Supply chain disruptions have cash flow implications across the extended supply chain that can’t be underestimated.
Here we will suggest ways organizations can mitigate damages to their business during the current COVID-19 pandemic.
Companies that will be hit the hardest
A survey jointly conducted by Tsinghua University and Peking University estimates that 85% of SMEs in China will run out of cash within three months, and two thirds will run out of money in two months, if the crisis does not abate.
Several municipal and provincial governments have also announced measures to help SMEs, with total support estimated in the US$70 billion range. However, the impact on businesses will extended far beyond China, and will only get worse if the virus continues to spread.
Businesses that are currently struggling for profitability—those with low cash reserves or unstable cash flows— are particularly vulnerable. However, even businesses that appear to be in good financial shape may not be immune, depending on how the situation progresses, and how long it takes for demand and supply chains to return to normal.
Responding to the immediate challenge
Given the importance of cash flow in times like this, companies should immediately develop a treasury plan for cash management as part of their overall business risk and continuity plans.
In doing so, it is essential to take a full ecosystem and end-to-end supply chain perspective, as the approaches you take to manage cash will have implications for not only your business but also for your customers.
Borrowing from the lessons learned from the SARS outbreak in 2003, the 2008 recession and credit crunch, and the last black swan event to significantly impact global supply chains–the Japanese earthquake of 2011–we offer the following practices and strategies for consideration:
1. Ensure you have a robust framework for managing supply chain risk
Supply chain management is a complex challenge, and finance-related problems only add to the risk. Do you know if any of your customers are in trouble and might be unable to pay for the goods and services you deliver?
If you manufacture a product and want to sell it to someone outside your borders, you typically require a letter of credit from a prime bank that proves the buyer can pay. This letter of credit not only provides a source of ultimate payment, it can also be used to secure inventory financing while the goods are in transit—so it’s important to make sure these letters of credit are still reliable.
Ensuring you understand the financial risks of your key trading partners, customers, and suppliers is a critical consideration in times like these.
2. Ensure your own financing remains viable
In these circumstances, don’t assume the financing options you previously had available to you will continue to be available. Undertake scenario planning to better understand how much cash you’ll need and for how long.
Use this opportunity to actively engage with your financing partners to ensure your available lines of credit remain available, and to explore new or additional options should you require them.
3. Focus on the cash-to-cash conversion cycle
Under normal business conditions, companies primarily focus on the profit and losses–growing the top line while managing the bottom line. Routine back-office activities such as paying bills and turning receivables into cash are often taken for granted.
In the current abnormal business conditions, smart companies are shifting their focus from the income statement to the balance sheet. Of the three elements of supply chain working capital–payables, receivables, and inventory–, supply chain executives have a tendency to focus on inventory.
But, in order to minimize working capital requirements during challenging times, it’s important to apply a coordinated approach that addresses all three areas.
4. Think like a CFO, across the organization
As supply chain managers step up to the challenges of disruption and inventory shortages, they generally spend their days thinking about operations and don’t pay much attention to finance and treasury issues.
More often than not, inventory levels and other critical business parameters are driven by customer service requirements and operational capabilities, not financial constraints. But what if the situation was reversed?
What if working capital was the company’s primary constraint on inventory, and supply chain managers were given the challenge of making it work? How would that affect your supply chain and inventory practices?
5. Revisit your variable costs
Reducing your variable costs is often a quicker way to immediately reduce your cash outflows than focusing on your fixed costs.
Of course, there are the typical variable cost-reduction levers, such as imposing travel bans and non-essential meeting restrictions (which might already be in place as a way to manage employee safety), imposing hiring freezes, and placing restrictions on discretionary spend like entertainment and training.
When labour is a significant cost line in your business, consider avenues that might help reduce spend to avoid getting to a situation where layoffs are required. For example, look for opportunities to reduce contract labour and re-distribute work to your permanent workforce.
Encourage employees to take available leave balances to reduce liabilities on the balance sheet. And, if necessary, consider offering voluntary, or even involuntary, leave without pay to preserve cash.
Written by: Deloitte
Continue reading: COVID-19: Managing cash flow during a period of crisis [PART 2]