Light at the end of the tunnel

The gloomy economic climate presents challenges to business, but even a downturn offers opportunities if flexible management structures are in place and ready to take advantage, as outlined by Paul Tuite of PwC

FOR THE first time in more than 20 years, the Irish economy faces recession. In this era of uncertainty the only point of agreement is that things will get worse before they get better.

Managers must consider the effects of the downturn on their business. They should address two key questions: What do we need to do differently? What do we need to do better? Many practical steps can be taken to minimise the effect of the downturn and position the business to emerge strongly when economic conditions inevitably improve.

Understand the true impact of the downturn on your business

When assessing how the downturn will impact on your business, you should pose these questions to yourself and your colleagues: How will our customers behave? How will our competitors react? What do we need to do well to minimise the impact of the downturn on us?

You need to assess how different segments of your customer base will behave in the downturn, assess how strong your competitors are and adapt your strategy to the changed conditions. Also you need to assess whether the new strategy has implications in other areas.

Given the volatility which exists in current markets, it makes sense to subject your assessment to stress testing and scenario planning. Only when you have considered the potential range of future outcomes can you determine the optimum course of action to take.

Unprofitable products and customers

When resources are limited it is critical to be aware of the profitability of individual customers and products. They need and deserve investment, while unprofitable customers and products require detailed analysis to determine whether or not the position can be rectified. Establishing product, customer and segment profitability requires thorough analysis to ensure that all costs are considered.

When this is done, corrective action can include price increases, cost reduction, amendments to terms of trade and, in some cases, it can even mean removal from your portfolio.

Once you have identified your profitable products and customers, invest the time and resources to stay close to them.

Cost reduction

Cost control is a necessary obsession for any business, but in a downturnit must be a prime focus of management. Sustainable cost reduction involves moving from your current cost base to a lower cost model. In the short term, the quickest route is to freeze recruitment and subject all hiring to rigorous scrutiny. The next target should be discretionary expenditure - segregate the essential from the desirable and limit accordingly.

In the medium term, cost reduction must come from examination of the present cost base and an assessment of the value derived from each significant cost category. This review should consider the level of cost in all areas of the business and then seek to identify where savings are possible.

In the longer term, cost reduction will involve driving down the business break-even point to as low a level as possible. This will involve examining just about everything. This kind of change cannot be achieved in weeks or months, but the threats presented by the downturn will persuade stakeholders of the need for regular reinvention.

Managing working capital

When "cash is king" everyone should be focused on minimising investment in working capital. This will limit reliance on lenders, contain financing costs and reduce the risk of loss.

Cash collection should be proactively managed - perhaps by offering customer incentives such as early payment discounts. You should process invoices on time and stay close to who pays you.

Consider giving your sales team incentives at the cash collection point rather than when the sale is made. Suppliers should be paid in accordance with agreed credit terms and not before due, unless attractive settlement discounts are on offer.

Inventory balances should be maintained at the minimum level consistent with agreed customer service levels.

Effective working capital management will require close contact with customers and logistics providers, ongoing review of your sales pipeline, the recalibration of inventory stocking levels.

Performance and forecasting

The function of management information systems can no longer be limited to the measurement of past financial performance. Focused reporting and effective forecasting are critical to both effective planning and day-to-day management, particularly in a downturn. In the short term, a focus on a limited number of key performance indicators (KPIs) is required. These should be transparent, unambiguous, easily understood and managers should be encouraged to deliver on them.

The medium-term perspective requires a strong financial forecasting capability. Rolling forecasts, produced as a matter of routine directly from the management information system will provide the necessary flexibility to plan for likely developments in the marketplace.

A well-resourced finance team

A downturn produces new challenges for all parts of an organisation, but the finance function will come under particular pressure to meet increasing demands for information to support initiatives throughout the business.

The resource needs in this area, in terms of people, experience and IT support must be a priority. Short-term needs can be met by contractors or secondees while the longer-term requirements of the business are assessed.

Financing arrangements

Inappropriate financing arrangements can mean that borrowings are unnecessarily expensive, or that your business has insufficient flexibility. In the current environment it might be thought that the chances of refinancing bank debt are slim. In fact debt funding is still available to companies with a well thought out plan and robust cash generation capability. Furthermore, you may be in a position to consider alternative sources of finance such as asset-based finance or leasing.

The key is to understand what is available in the market, to identify the structure that best suits your business, to consider any tax impacts and to negotiate effectively with your lenders.

Mergers and acquisitions activity

Lessons learnt from previous downturns have shown that merger and acquisition opportunities will present themselves in most industries. The key to availing of these opportunities is having the flexibility to move quickly. There are particular skillsets required in acquiring distressed businesses and experience shows that if deals are effectively managed in a downturn, there is the potential to generate above average returns once trading conditions return to normal.

Careful tax planning

It is important not to lose sight of the importance of careful tax planning when dealing with the downturn. While still ensuring that your organisation remains fully tax compliant, it should be possible to improve your cashflow position by reducing or deferring tax payments. Opportunities here would include making maximum use of losses in calculating preliminary tax payments, availing of VAT relief on bad debts and ensuring that all available deductions are being claimed.

At a strategic level, falling asset values can also be taken advantage of for crystallising losses and tax effective succession planning. From a human resource perspective, tax-efficient remuneration strategies and cost-effective pension provisions are more important than ever.

Communicate with stakeholders

Managing the stakeholders in a business is critical, especially in difficult times. The key is timely and honest communication. Withholding information or springing surprises is likely to unnerve people and erode their confidence. While the required communication can be very time-consuming, it is an important investment.

Manage key talent effectively

The 2008 PricewaterhouseCoopers Global chief executive survey highlighted that concerns over people and talent far outweighed fears of recession. Ensure you motivate and develop high-performers. Watch for pressure points, but also be aware that key talent may be more readily available for recruitment than was the case in the boom times. It is also likely that recruitment costs and packages will be more competitive in a downturn.

Challenge as opportunity

In a downturn, numerous difficulties present themselves. A natural response may be to "batten down the hatches", but it is important to recognise the opportunities presented. Thriving in a downturn requires greater diligence and skill than during more favourable economic times. However, the rewards can be greater as businesses that adapt quickly with the right strategies can not only grow, but position themselves strongly for the inevitable upturn.

To discuss opportunities in these areas with PricewaterhouseCoopers, please contact:Paul Tuite on (01) 792 6502 or paul.tuite@ie.pwc.com