TRADITIONAL thinking suggests that businesses retrench and cut back on investment when there is a downturn in the economy. On the contrary, businesses should view this period as an opportunity to refocus rather than merely cut spending. Companies that effectively manage risk and prepare for the rebound during a downturn can actually improve their competitive position during this period.
Many companies will enter 2009 with uncertainty. The credit environment is making it more difficult to secure financing and has raised the cost of capital. Falling consumer confidence has decreased consumer spending, while inflationary concerns and declining revenues and profits are putting a strain on working capital. Good cash management becomes particularly important during these times when companies have restricted access to new funds.
The immediate challenge for most companies is coping with deteriorating receivables and pressure for payment from suppliers. Managing cash outlays - from payables to dividends - during a downturn can improve a company's cash position and increase its financial flexibility.
Performing an analysis of cash outlays to determine the payment types that can be decreased (cost reduction), delayed (capital projects), or improved (vendors) can aid in preserving cash. Companies should also look for strategic vendor alliances and leverage the downturn to contract with those vendors on more favourable terms.
Other than managing cash outlays and payables, other working capital challenges include inventory and receivables management.
Typically in a downturn, companies look for ways to reduce costs through across-the-board cuts. Rather than impulsively cutting budgets, companies should take this opportunity to refocus efforts on areas that improve the bottom line (eg, increasing productivity, targeting customers). Otherwise, indiscriminate cost-cutting can impact a company's ongoing ability to maintain day-to-day operations.
As an example, while companies should review information technology (IT) operations for operating efficiencies, they should also consider opportunities to use IT more effectively to achieve their strategic goals. From another perspective, companies that try to reduce IT costs through outsourcing or relocating their IT function to countries with lower business cost may inadvertently increase risk exposure to new threats. These can arise as a result of cultural, political and regulatory differences, lack of understanding of local business practices, security lapses, as well as natural disasters.
Most companies may also be re-examining their portfolio of capital projects during this time. A company's capital projects portfolio may include construction of new manufacturing facilities, enterprise resource planning (ERP) implementations, business process standardisation initiatives and new product development research. Simply cutting off funding for these projects to preserve cash during the downturn can affect a company's ability to position itself for the recovery.
Instead, companies should review their capital projects portfolio and assess how each project aligns to the company's strategic plan in terms of short-term needs versus long-term goals. Programmes geared towards improving the company's efficiencies and reducing cost may be moved forward. On the other hand, the timing of projects intended to expand market reach or launch new products could be adjusted to coincide with the forecasted economic expansion.
During economic downturns, the pressure and opportunity to commit fraud may increase. The increasing pressure on management to sustain the company's business and meet stakeholder expectations in this difficult climate also makes fraud easier to rationalise. Ironically, as companies seek to reduce costs, investments and efforts in the areas of governance and risk management may decrease, leading to increased opportunity to commit fraud.
Management should recognise that stakeholder confidence and a positive brand can take years to build but can be severely damaged by a single incident. Greater focus on governance, continuous reinforcement of ethical and legal responsibility, providing mechanisms to report and monitor fraud, and having a plan to quickly respond to an incident are key to mitigating the impact of fraud on a company.
Additionally, having a code of conduct, an active audit committee, and a clear and consistent message regarding ethical behaviour can help reduce the risk of management override. An active audit committee and board that ask tough questions, challenge management assumptions and take an active role in reviewing the company's financial results will also help mitigate the risk of earnings management. Companies should not overlook the importance of timely and transparent communication with major stakeholders.
The downturn also offers opportunities for companies with greater balance sheet flexibility to leapfrog their competitors by continuing to invest and grow inorganically. This can be achieved through mergers and acquisitions, or buying cheaper assets from distressed sellers. However, companies should still re-evaluate domestic and international growth opportunities in a pragmatic and cautious manner.
Make the most of any acquisition with a post-merger integration plan to carry through the programmes that will help management drive synergies, eliminate duplication and reduce costs. The focus here is not to simply squeeze out costs, but to align the business and enhance its performance through efficient use of resources.
In contrast to what companies can usually expect in good times, inefficiencies such as duplicate business processes and incompatible or redundant IT systems can have a greater negative effect on a company's margins in a downturn. The impact from the loss in efficiencies from mergers may not be cushioned by the additional revenue and profit obtained from the acquired company.
As companies manoeuvre through a host of obstacles and pitfalls during the downturn, management should understand that managing risk does not mean avoiding it altogether. For companies that are now developing strategies on how to manage risk through this downturn, it is important to have a balanced focus on the 'now' and the 'future'.
Focus on the immediate issues of today such as managing working capital, addressing pressures on revenues and costs, and managing potential risks to corporate brand and reputation but do not lose sight of the future.
Remember to also look at capitalising on market opportunities, investing in the 'right' capital programmes and taking advantage of potential bargain transactions that can drive future growth.
John Chin is a partner of Ernst & Young Solutions LLP.
This article was first published in The Business Times on November 28, 2008.
