Published: 19 May 2020
Analyst(s): Finance Research Team
This research describes four imperatives CFOs and their teams must follow to ensure they’re prepared to restore financial investment levels in a timely manner when the economy shows signs of recovery.
Short-term concerns regarding liquidity and cash flow health as the COVID-19 pandemic deepened have shifted companies’ focus toward maintaining operational and business continuity. In the process, longer-term growth bets often were set aside. As the immediate financial concerns surrounding the pandemic gradually abate, CFOs have an important role to play in steering the company beyond immediate and obvious opportunities to preserve profitability. They must shift to ensure they will have the financial resources ready and available to invest in an effective recovery.
Past downturns have shown that companies that are decisive in restoring investment levels as the economy recovers are more likely to achieve simultaneous top-line growth and bottom-line margin improvements.
Companies overly focused on short-term liquidity demands, in the aftermath of the COVID-19 outbreak, now need to shift toward building financial preparedness for investment.
Getting ready to jump-start investments requires CFOs to ensure ongoing access to cash and build the leadership visibility into evolving growth and risk drivers.
As most companies review overall operating costs and curtail nonessential expenses in response to the COVID-19 pandemic, it is natural for conversations about long-term growth to take a back seat. Most finance leaders (65%) report suspending all or at least some long-term growth investments (investments with a three-year or longer payback).
Looking ahead to when the global economy recovers, questions about investment strategy will again dominate executive boardrooms: Which products, markets, and customer segments are best suited for strategic bets? What return profile is acceptable? When do we time our investments to minimize risk and maximize reward?
Our research on companies that grew both revenues and margins over a sustained period of time (what we refer to as “intelligent growth” companies) shows that in choppy economies, successful companies restore investment levels more decisively than their peers. The experience of these and other successful companies reveals four imperatives CFOs can follow now to enable swift action on investment decisions as the pandemic shifts from response to recovery and renewal. Of course, these are predicated on organizations having developed sound investment plans for the postpandemic era. With those plans in place, CFOs must ensure their organizations can act on them by:
Building a clear understanding of available capital to ensure the company is ready to invest when the time comes.
Continuously pressure-testing capital forecasts to ensure they support the investment plan as conditions change.
Adjusting metrics to ensure the organization keeps an eye toward the long term.
Making sure everyone is aligned with the organization’s investment approach to avoid time-delaying debate.
The financial crisis arising from the COVID-19 pandemic has led to liquidity constraints as corporate earnings plummet across most industries. Many corporate balance sheets were not strong heading into this scenario, and there is also some concern that despite central bank actions, credit market liquidity will be threatened in a long-term downturn. CFOs must continue to maintain sufficient focus on keeping the capital available for long-term focused investments.
Two strategies will enable this.
To ensure consistent and adequate cash flow for investment, CFOs must increase emphasis on short-term planning. Seven out of 10 finance leaders are conducting cash flow forecasts more frequently than on a weekly basis. A winning combination during the crisis period could include:
A short-term (13-week) rolling cash forecast, reviewed weekly with the management team and used to chase down any major working capital issues.
A longer-term (18-month) refresh of all three financial statements (P&L statement, balance sheet and statement of cash flows) on a rolling basis, used to check compliance with loan covenants (such as change in EBITDA and cash positions).
Shorter planning cycles will naturally strain finance resources. CFOs must make deliberate decisions to discontinue some noncritical finance processes and initiatives, such as in-depth variance and assumptions testing, reporting enhancements and finance IT tools/systems development. The freed-up resources can then be reassigned toward critical reporting activities and daily and weekly updates on critical planning inputs, such as economic outlook information (including governmental strategies and communications), inventory and counterparty risk, and cash outflows.
Apart from being an important source of liquidity, bank partners’ insight into current capital market dynamics makes them well-positioned to help validate a company’s capital planning framework.
Meeting with multiple bank partners and getting the right information out of them can be challenging. Our past research revealed how Perrigo, a pharmaceuticals company, ensures discussions stay productive by conducting a “reverse roadshow” — a meeting in which bank partners gather to talk about the company and help the CFO test capital planning assumptions. The typical agenda for the reverse roadshow is as follows:
The senior executive team meets with a group of leading bank partners to discuss Perrigo’s core direction and anticipated capital demand.
The team runs through their own assumptions regarding capital availability, WACC and the cost of funding for the year.
Bank partners provide their independent view of the capital markets, future cost of funding and covenant flexibility.
Through such recurring meetings, Perrigo effectively involves its bank partners in helping test and validate the company’s ability to meet its strategic objectives in concert with balanced liquidity and market access against the cost of capital.
The decision of how much capital to maintain is one that companies often underinvest in. Companies that are unconfident in their assessments of liquidity and capital needs are likely to lose out in the upturn by making either overly conservative or overly aggressive business investments. CFOs must institute a process to continuously validate capital planning assumptions.
Genentech, a biotechnology company, uses an analytically rigorous yet conceptually simple cost-benefit model to determine what level of cash most efficiently insures against financial distress. In Genentech’s model, the benefit of incremental cash is defined as the reduced marginal probability of financial distress given the liquidity buffer. For example, holding $1 billion rather than $500 million in balance sheet cash leads to fewer projected covenant breaches, greater value from the M&A/R&D pipeline, and so on. Genentech extends this analysis by running Monte Carlo simulations to determine the frequency of distress scenarios at different starting liquidity positions (see Figure 1). It then quantifies the benefit of holding additional cash (or credit lines) using average market impact of observed distress events in other comparable companies.
Pushing business leaders to think long-term during a time of crisis is challenging. Investment decisions are often prone to recency bias as executives are unaware of, or underestimate the scope of, cyclical and structural business and customer trends. To avoid shortsighted decisions that can hamper long-term growth, CFOs must ensure performance management (incentives, metrics, subjects discussed in operating reviews) aligns with the plan for the recovery and renewal phases.
The CFO at Lowe’s recognized that static performance dashboards focused the company on the wrong metrics as it transitioned to a new economic phase. As a solution, the CFO developed a dynamic metric cascade to swiftly shift focus onto different levers and behaviors important in any given phase (see Figure 2). Using a headline metric, such as return on invested capital (ROIC), allows the CFO to dynamically adjust a range of financial performance levers based on current market realities without losing sight of the overarching company goals.
The board of directors and C-suite leaders are important stakeholder groups that can provide CFOs invaluable feedback on the actions planned or taken to preserve and grow the business. In times of crisis such as these, it is very important for stakeholders to receive as much clarity as possible regarding the organization’s capital planning approach. However, overly detailed and technical presentations can reduce stakeholders’ ability to provide actionable recommendations.
Contingency-based plans (that is, in the event of X, we will enact Y) are effective in demonstrating the company’s ability to withstand different downturn scenarios. For example, Brocade’s treasury team models the impact of risk scenarios and risk continuity plans on baseline liquidity levels over time (see Figure 3). By showing risk and opportunity, not just point estimates of key quantities, Brocade’s CFO makes it much easier for nonfinancial board members to grasp the issues at stake and provide meaningful feedback into the model.
Distilling complex financial concepts into simple graphics can better communicate information to nonfinancial audiences. For example, when presenting capital supply and demand calibration for the year, one company puts the sources and uses of long-term capital on the same slide. This provides a more concise and effective snapshot of the company’s ﬁnancial risk appetite than if the two pieces of analysis were presented separately.
As the COVID-19 crisis retreats, ushering in an era of capital deployment choices with serious competitive implications, companies will need to be more disciplined in managing capital. To make smart, aggressive business investments in the future, CFOs must ensure continuous visibility into the company’s short-term capital supply. They must realign metrics to current drivers of financial performance to avoid making uninformed, short-sighted decisions that could have lasting implications for the company. They must continuously pressure-test the validity of capital planning assumptions. Finally, CFOs must align the extended ecosystem of business leaders and board members on the company’s capital plans to drive timely and effective investment decisions.
We’ve assembled resources and tools exclusively to help finance leaders with their planning as the COVID-19 pandemic and related economic disruption continue.
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Review how Genentech simulates risk scenarios to rightsize its cash cushion.
Learn how Brocade establishes broad visibility into risk tolerance and strengthens liquidity planning by using “real” risk scenarios.
This research highlights the four actions CFOs must take to enable swift investment in the COVID-19 recovery. It is based on best practices and guidance in recession and recovery preparation by Gartner.
Gartner COVID-19 Finance Quick Poll 8 April through 12 April (2020)
Guiding Principles on Independence and Objectivity.