In the final article of our Lessons Learned from COVID-19 series, we discuss the importance of financial modeling on the resiliency of Canadian businesses.
Given the current level of market uncertainty, financial modelling has become increasingly important in helping organizations unlock the financial insights needed to make critical business decisions. However, effective financial modelling is usually an extensive exercise and, for those organizations that do not have adequate resources, it can be particularly challenging.
Leadership’s ability to respond to an event of this magnitude is severely impaired if they’re merely reviewing last year’s results, adjusting for growth and dividing by 12 to arrive at a monthly forecast. In a crisis, critical decisions have to be made weekly, and sometimes daily, to allow an organization to navigate a path forward. Higher quality data and stronger financial insights allow your leadership team to make more informed and effective decisions, when time is of the essence.
To gain access to these robust financial insights, therefore, it’s critical to implement more advanced financial forecasting models—with features like built-in sensitivity analysis, comprehensive dashboards and the ability to quickly update information as it changes. Such models not only make it easier to access relevant financial information quickly, but can also help companies develop the detailed forecasting that lenders are increasingly demanding.
Case study: A tale of two financial forecasting models
When COVID‑19 hit, Company A opted to continue basing its decisions on its traditional financial model, believing it had a good enough understanding of its financial situation to weather whatever storm COVID‑19 had in store for it. Company B, meanwhile, decided to revamp its financial modelling approach and completed a detailed 26-week cash flow model.
Thanks to Company B’s detailed model, their leadership team was able to anticipate a significant revenue drop, which would result in a significant cash flow decline as early as July. This allowed the company to think outside the box and develop a new revenue stream, which was scheduled to come online around the same time. It also allowed the company to proactively set the wheels in motion for additional financing from its lender. Management was even able to facilitate the discussions with their lender by providing a snapshot of the forecast model to support their financing needs and their ability to recover.
During this same period, Company A, using their existing financing model, did not foresee a dip in cash flow and was caught by surprise when it occurred in June—something the leadership team was later able to attribute to a drop in sales and a slowdown in receivables in May. Caught somewhat off-guard, the negative cash flow situation sent the company into a panic, as it struggled to balance its day-to-day operating cash flows with its regular debt payments.
While both companies approached their lenders for help, the lender responses were very different. Because Company B was able to prove, through its detailed cash flow model, that its cash flow shortage was not only temporary, but that it had a plan to ensure long-term sustainability, it was able to obtain the additional financing it required. Company A, on the other hand, ended up making a choice to prioritize its operating costs over its loan payments, eventually forcing the lender to transfer the account to its special loans division. When Company A finally went to the bank requesting additional financing at the eleventh hour, the bank decided to decline. Company A had to search for alternative lenders to cover the gap.
In addition to outlining the importance of being proactive in a crisis, this story underscores a growing reliance on continuous financial modelling as a best practice. There are often multiple actions that can be taken in advance to help reduce a decline, or to counteract it, both in a crisis scenario and as a result of unexpected slowdowns or increases in demand. In our experience, today is always the right time to improve your financial modelling to provide better information, which will allow your leadership team to make the right decisions at the right time.
Innovation inspiration: Adapting to surging demand
While many companies saw demand plummet in March, that wasn’t the case for one hot tub manufacturer. With more people stuck at home, many were opting to make the most of it by acquiring a hot tub. As a result, this manufacturer saw orders surge from 550 per month to 2,000 per month. In response, they took steps to ensure all of their facilities were working at full capacity. In addition, rather than shutting down their showrooms after selling out of their floor stock (which many of their competitors did), this company opted to start taking pre-orders for 2021. The moral of this story? While a crisis may result in revenue declines for many companies, sometimes it can result in an unexpected increase in demand. To succeed, companies need to be able to respond to both scenarios effectively and quickly—and that starts with establishing a strong understanding of your business’s financial position, financial risks and opportunities for growth.
The path to resiliency: The fundamentals of sound financial forecasting
If you’ve been having difficulty predicting future sales and cash flow requirements, there are things you can do to enhance your view of the financial picture:
Model a number of different scenarios
In this COVID‑19 world, anything can happen and you need to be prepared. Not only should you build multiple scenarios to cover a variety of potential situations, but also make sure those models are regularly updated—because, as we’ve seen, things can change fast.
Revisit your original budgets and forecasts
Regardless of whether COVID‑19 has made your business busier than ever or has had a catastrophic effect, you need to be willing and able to reforecast, possibly even weekly if things are rapidly changing, to give business leaders the information they need to make informed decisions in-the-moment.
Strengthen your existing financial practices
To thrive in a crisis, you need to be able to quickly make sound financial decisions. Now may be the time to re-examine your financial modelling and cash flow processes, and potentially invest in new tools—such as upgraded financial models or even an ERP upgrade—to ensure you have the clearest view possible of your financial picture.
Stay close to customers to better understand future demand
As customers’ willingness to purchase shifts in response to changes in the marketplace, it’s important to keep your finger on the pulse of evolving demand dynamics. By having regular conversations with your customers, and by using tools to forecast expected revenues and sales, it will become easier to identify potential cash flow issues or an inability to meet demand down the road—or even to devise alternative product or service offerings your customers could benefit from.
Finding the way forward
It goes without saying that, in these unprecedented times, “business as usual” no longer exists. Yet, as we’ve seen from the IBR, our roundtable discussions and countless conversations with Grant Thornton clients, it is possible to move forward in this new normal—by prioritizing agility, learning from other business leaders and being willing to embrace uncertainty.
That said, if you’re having difficulty in this new era, rest assured you’re not alone. If you’d like a fresh set of eyes or a more experienced hand to provide you with some guidance along the way, it may be a good time to strengthen your internal team or to reach out for external support.
At Grant Thornton, we have helped countless companies thrive in the face of uncertainty—and many of those lessons apply today. If you’d like to discuss your challenges with a Grant Thornton advisor or you need help identifying new opportunities in today’s marketplace, please don’t hesitate to reach out. We’re here for you.
To read the full report, "A blueprint for moving forward: Lessons learned from COVID-19," download the PDF.