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.