DealMakers - Q3 2020

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Business recovery and responding to liquidity and debt challenges

Chris Gavrielides

The unprecedented disruption and uncertainty caused by COVID-19 will continue to have a damaging effect on businesses of all sizes across the business ecosystem, and will present them with unforeseen challenges – most likely in the form of financial instability and cashflow constraints. The South African economy was already significantly constrained pre-COVID-19, with many businesses struggling to find liquidity, comply with debt obligations and manage their economically vulnerable position. These challenges were exponentially exacerbated in the wake of the pandemic. More recently, we have seen companies paying lower dividends and a number of JSE listed companies issuing profit warning announcements. It is also anticipated that the liquidity and debt challenges faced by companies will have an impact on their ability to comply with financing obligations and commitments.  

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Chris Gavrielides

Preparing for this unsettling period will be an on-going process; so too will modifying action plans and disaster-recovery policies that respond to the unique and evolving challenges this pandemic presents. The time to start implementing measures to secure business survival is now. Proactive measures are required, even for companies that are not yet experiencing financial difficulty.

 

The first step in assessing a company’s readiness will be to identify vulnerabilities and financial stability. It will be critical to recognise that the model for success will be different in the future. Although longer term planning will be important, in the short to medium term, the focus should be on how businesses will recover.

What businesses will require is sufficient funding and the right operating model to emerge successfully. A robust and detailed recovery plan will be essential for most businesses to support their recovery from the crisis. A recovery plan will need to be suitably responsive to anticipate and identify the options and corresponding practical actions required. Early planning should inform current decisions to ensure that businesses are able to recover as smoothly and effectively as possible.

 

The core elements of a business recovery plan are as follows:

  • A short-term cash flow forecast;

Given the predicted levels of uncertainty, a robust cash flow forecast will be an essential component of the recovery plan. Properly prepared, a short-term cash flow forecast is an effective tool to understand the immediate cash requirement of a business and identify possible steps that can be taken to allow the business to operate within available cash resources. In addition, it may take some time to develop a longer-term plan for the business and, if necessary, secure appropriate funding. Careful and regular monitoring and management of cash in the intervening period may prove critical to effectively navigating the early period of the recovery and, possibly, the survival of the business.

 

  • A strategic plan for the business;

Businesses will have to be agile and reactive. However, despite this need for flexibility, it is critical that businesses have a base case view of their strategy and use this to inform how they navigate their recovery. If a strategic plan does not exist, then one should be developed as a matter of priority. The anticipated path to recovery will be central to the strategic plan. Critical questions will need to be answered, such as, “Will the business immediately revert to pre-crisis levels of revenue, production/service provision and employees, or is a phased recovery more likely and what will this look like?”

 

  • An operations plan to deliver the strategy;

It will be necessary to consider whether changes to the operational aspects of the business are required. The focus of this will be on cost reduction and performance improvement actions to allow the business to capitalise on opportunities. Operational activities may include implementing new ways of working, reconfiguring the operational footprint and, if necessary, a closure of parts of the business.

 

  • An integrated financial forecast model, covering the next 12 to 24 months’ trading period;

The strategic plan should be modelled in an integrated financial forecast in order to fully understand the associated financial implications and the quantum/timing of any funding requirement. The forecast should also incorporate operational cost reduction/performance improvement plan activities. In addition to the base case, realistic alternative scenarios should be modelled so that any significant financial implications can be understood, and contingency plans developed if necessary. The forecasting process should not be a static, one-off exercise, but rather a dynamic tool used to support decision-making as the business navigates its recovery.

 

  • A funding review, covering both internal and external sources of finance;

The integrated financial forecasts may indicate a funding requirement to support the implementation of the base case strategic plan. Where this is the case, a funding review should be performed which takes a structured approach in considering the available funding options and ensuring the business secures the sources of finance it requires. The focus of a funding review should initially be on internal sources of funding (i.e. working capital improvements), followed by potential creditor payment plans and available debt or equity sources.

 

  • Contingency planning

Uncertainty is anticipated to be a significant feature during the recovery period and there may be a risk that the strategic plan cannot be delivered and/or the business cannot access the required levels of funding. Given this, businesses should develop contingency plans which could be implemented if required.

 

The crisis does not come at a good time for South African businesses, who have witnessed an increase in corporate insolvencies and companies requiring business rescue or undergoing significant restructuring. Financial institutions are critically reviewing their leveraged positions and are implementing corrective measures for businesses that are showing signs of distress. The importance of liquidity is crucial to ensuring a company has the flexibility to navigate these turbulent times. Cash preservation is paramount and businesses will need to prioritise where cash is deployed. In addition, balance sheets could be better utilised even if securing additional credit facilities proves challenging. Only three things are certain: death, taxes and the need to be pro-active in order to ride the future waves of economic crisis. 

 

Gavrielides is an Associate Director, BDO Corporate Finance.

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