Assess financial risks early and often

Many businesses have started to feel the strain that COVID-19 puts on their profit margins, ranging from rising procurement expenses, hampered supply chains, to falling demand.

The situation calls for a framework that helps assess and forecast the financial conditions of companies under scenarios unfolded by COVID-19. The framework's prime goals are to spot early potential problems about the availability of working capital, and to identify actions to ensure adequate cash flow.

Below are four basic guides to establishing such a framework.

1. Assemble a core financial risk management team

Its main role is to manage a company's liquidity risk during the COVID-19 outbreak. It could be composed of the chief financial officer as the team leader, representatives from treasury, credit, legal, business development, and a financial analyst.

It is vital to keep the team small and nimble with full decision-making authority.

2. Conduct rapid assessments of liquidity risk iteratively 

Both internal data and publicly available sources could be used in the assessments. For variables that directly affect the company's revenue and cost, their input values should be calculated with rigorous analytics.

The assessments typically include the modelling and forecasting of cash flow, profit and loss, and balance sheet in different business scenarios, which are tailored to the company's current financial circumstances by the core financial risk management team.

The scenarios should also take customers' credit risk during the outbreak into account, especially when the customers:

• Delay payments
• Default on payments
• Demand to extend payment terms
• Have cash flow strains
• Have their own customers delay or default on payments to them
• Have their sectors directly affected by COVID-19
• Have their businesses shut down
• File for bankruptcy

Thorough assessments will lend insights into the crucial liquidity issues in each scenario. The core financial risk management team can then sort the issues by using a grading scale to present an overview of COVID-19's implications for the company and where the most critical issues lie.

As the situations surrounding COVID-19 develop, the core financial risk management team should perform assessments regularly to stay up to date with any shifts in the seriousness of potential cash flow issues.

By giving greater visibility to cash, the team helps the company maintain control and be proactive in coping with the uncertainty that COVID-19 causes.

3. Run financial stress tests in parallel with the risk assessments under each business scenario

Stress testing the company's capital requirements frequently helps the core financial risk management team present an informed view of the company's liquidity during the outbreak. Stress tests also give the company a clear idea about how their finances might be handled in dire circumstances.

4. Find remedies to cash flow risk

Based on the risk assessments and financial stress tests in the alternative business scenarios, the core financial risk management team could outline courses of action to prevent potential cash flow issues from impairing liquidity. Common examples include optimising accounts payable and accounts receivable and reducing costs.

Maximise cash flow with accounts receivable

Amongst the levers that businesses could pull to improve their cash flow, accounts receivable are often the most challenging. Because most companies have little control over their customers' payment behaviour.

However, with accounts receivable being the biggest asset on a company's balance sheet, and businesses needing to bolster cash inflows as much as possible to weather the storm of COVID-19, optimising collections and limiting bad debt losses become paramount.

The seven accounts receivable best practices in turbulent times below could aid businesses in building financial resilience.

1. Use analytics to categorise customers

Different collections strategies can then be designed to fit the different customer categories. A basic three-tier system may comprise:

"Good" customers	They are in a strong financial position and pose almost no credit risk. COVID-19 has minimal or no effects on their sectors or payment behaviour.
"Fair" customers	They are in a relatively good financial position and pose low credit risk. COVID-19 could affect their sectors negatively, both directly and indirectly. Therefore, their payment behaviour could be adversely influenced during and shortly after the outbreak.
"Poor" customers	They are in a weak financial position and pose considerable credit risk. COVID-19 affects their sectors directly and severely. The pandemic threatens their solvency further and can cause them to default on payments in the near future.

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2. Consider providing them with short-term relief in exchange for prompt payments

Especially when the customers are in temporary financial distress (i.e. "Fair" customers). An example of short-term relief is suspending interest and late fees.

If it is possible, also consider giving them incentives to encourage early payments. Sometimes small discounts are enough to speed up the collections of such accounts during economic hardship.

3. Consider working out payment plans with them and accepting what can be collected today

Especially when the customers have cash flow problems and cannot pay in full (i.e. "Poor" customers). This is better than having to write the accounts receivable off later in the event that COVID-19 worsens the economic downturn.

4. In general, be willing to renegotiate payment terms with customers

Renegotiating gives companies more chance of collections, as long as the renegotiated terms align with their credit policy. The key is being diplomatic while being insistent on settlement terms.

5. Offer payment methods that are easy for customers to pay

Also, make the payment process as frictionless as possible, taking into account that the customers may lack staff dedicated to accounts payable or the staff may work remotely.

6. Ensure the accuracy of customer master data

Any changes in customers' credit profiles, any standard and customised terms applied, and any collections efforts and agreements should be duly recorded. This makes certain that invoices are sent without errors, collections are executed with the right approach, and disputes are handled in the right manner.

7. Adjust collections operations to the availability of the workforce

Depending on each company's circumstances, their collections staff may only conduct part of their collections activities or have to suspend them all. To prevent COVID-19 from hindering collections efforts, consider establishing a strategic partnership with a collections agency where collections efficiency and capacity are assured.

Improved cash flow brings financial flexibility, which in turn increases companies' resilience during downturns ⁽⁵⁾. It is imperative to regularly optimise balance sheet and tailor collections strategies and approaches to the insights obtained from financial risk assessments and stress tests.

Prioritise speed and collaboration

The speed of COVID-19's development worldwide is a huge challenge for businesses. The scope and impact of its implications have changed so fast that the responses many companies mount today may not apply any more the next day. The fear of not being able to keep up might render businesses passive or inactive, but this is what they should avoid at all costs.

There is no use in waiting until threats materialise before deciding on a course of action. With unprecedented and unpredictable events like the COVID-19 outbreak, such threats will seem to materialise out of nowhere, and by then, it might already be too late.

To respond timely and efficiently to the financial risks and uncertainties that COVID-19 creates, businesses could run decision-making cycles frequently. Each cycle contains three phases:

First phase	Analyse the most up-to-date external and internal information (including financial models, forecasts, and stress tests).
Second phase	Identify actions to mitigate cash flow risks.
Third phase	Prioritise the actions and carry them out.

As long as businesses could run decision-making cycles at reasonable tempos, they can adapt quickly as the pandemic unfolds and build resilience based on the actions that work.

Speed could again be a tough challenge here. Companies may have weak oversight of their workforce when most of their staff work remotely. Some companies may not afford to hire and train staff during the outbreak. Some companies may even have to downsize their workforce.

At times like this, businesses could explore collaborations with third parties as strategic partners to ensure effective operation of functions such as accounts receivable. A strategic partner in collections with a capacity to perform globally amid the COVID-19 outbreak could help companies:

• Adapt collections approaches to the development of the pandemic.
• Augment internal efforts to collect outstanding accounts receivable.
• Address accounts receivable issues and disputes.
• Aid the execution of companies' contingency plans to minimise cash flow risks.
• Make a plan to manage accounts receivable once the outbreak is over.

To cope with the upward pressure that COVID-19 exerts on the global economy, businesses need to develop the capability to improve cash flow and maintain financial flexibility. By assessing cash flow risks regularly and implementing effective measures promptly, they can be proactive and resilient in the face of the black swan of 2020.

 

_{Source:
^{(1) (3)} Atradius Economic Research, 'Coronavirus: an unwelcome guest at a bad time', March 2020.
⁽²⁾ Atradius Economic Research, ' Corporate insolvency growth to accelerate in 2020', March 2020.
⁽⁴⁾ McKinsey Global Survey results, ' Economic Conditions Snapshot', March 2020.
⁽⁵⁾ McKinsey podcast, 'Stronger for longer: How top performers thrive through downturns', December 2019.}