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Why cash management should be the cornerstone of your inflation strategy

Posted by Shivali Anand

June 15, 2022    |     8-minute read (1535 words)

The inflation rate for May, as assessed by the Consumer Price Index, was 8.6%, its highest level in over four decades. Not surprisingly, most business owners complain about the effects of high inflation, but it can also be an opportunity to boost long-term earnings and clean up business processes.

The role of cash management



Cash management is a deciding factor in whether a business thrives in its sector. A lack of free cash flow or poor cash management may cause excessive debt, potentially even leading to bankruptcy. This can be avoided by maintaining a healthy cash management system. 

Corporate bankruptcies precipitated by the COVID-19 pandemic illustrate how important it is for businesses to keep sufficient cash reserves. On the other hand, becoming too conservative and hoarding cash diminishes the value of that cash and might hamper future opportunities for investment and development.

Expert-vetted cash management tips



Business owners can enhance their cash management methods, in inflationary periods and beyond, by adhering to the steps below.

1. Develop projection models that take unanticipated circumstances into account.



Businesses must plan for what-if scenarios, such as a significant customer shift or unforeseen expenditures, to effectively manage their cash flow. This is even more crucial for the long-term survival of businesses with a smaller customer base. 

“2020 is the most recent experience that we are bringing forward into the current environment,” ServiceNow CFO Gina Mastantuono told Fortune magazine. “We constantly look at our plans, prioritize and make adjustments as necessary. We continue to be disciplined in our spending and remain agile.” 

Businesses can identify areas that present the most significant operational risk by considering as many adverse scenarios as feasible. Leaders can then make informed decisions about their cash management strategy. 

2. Delay cash outflow wherever possible.



Cash inflow and outflow are intrinsic to cash flow management. When it comes to managing outflow, it is essential to reduce costs whenever practical and postpone spending money for as long as possible while avoiding incurring financial penalties. It is also important to maintain decent credit rating to secure the best possible payment terms from vendors.

Capital expenses are another massive drain on cash flow. One way to minimize outflow pressure is to repair or acquire secondhand equipment whenever possible. Stretch your funds by waiting to make modifications or replacements until absolutely required.

With ongoing ultra-low borrowing rates, it's possible to retain more cash on hand by financing large orders. In addition, forward-thinking companies should reduce their inventories to the greatest extent feasible while still meeting operational requirements.

3. Maintain consistent and timely inflows.



As quickly as feasible, cash inflows should be collected. Providing consumers with discounts for paying their bills earlier, even if those reductions are as small as 2%, can be just enough encouragement for customers to pay their bills sooner. Business owners must keep track of late payments and re-evaluate business partnerships that aren't working. It is also possible to free up cash by selling or renting out surplus equipment or property.

4. Set up a fund for unexpected expenses.



Cash reserves for unexpected expenses are something that should always be maintained by businesses. This gives you breathing room and peace of mind in the event of a downturn. Three to six months' worth of costs is a fair benchmark to strive for.

How inflation affects businesses



Every company will experience the impact of inflation differently. But when prices climb, most businesses experience higher costs for raw materials, manufacturing and overhead costs, as well as lower sales as consumers' buying power erodes.

Inflation's immediate effects also include supply shortages that stop finished goods from being ready for the market. To solve immediate shortages, businesses generally raise their prices, speed up their shipments, hire additional workers or pay overtime to existing employees. All of this puts pressure on a business's expenses. Many business owners cannot transfer these extra costs onto their clients or consumers, because of pre-existing contracts or intense competition. Consequently, additional expenses may simply be deducted from the bottom line.

6 ways to get your company ready for an economic downturn



The possibility of a looming economic downturn is creating a lot of talk among economists. However, there is no guarantee that there will be a recession. Many economists see reasons to be optimistic, the most important of which is that consumer confidence is still high and unemployment rates are still low.

When it comes to predicting future events, market experts can only make informed guesses. Still, any business owner with a clear head should be ready for the worst.

When there is a recession, most businesses don't come out of it unharmed. However, cautious preparedness can make a difference. Ensure your company has the best chance of withstanding the pressure by following these six suggestions. 

1. Diversify your revenue sources.



An economic downturn has a way of affecting every link of the supply chain. When a customer has an issue, it can rapidly morph into one of your biggest problems. That means you shouldn't place too much of your earnings at the mercy of a small number of customers.

Analyze the types of customers you have. If a single customer accounts for more than 10% of your revenue, or if your top five customers account for more than 25%, you need to broaden your customer base. Look for methods to build a wide range of new connections and generate several diverse cash flow sources.

2. Optimizing operations.



By reducing or reallocating specific expenditures, CFOs may be able to make their processes more effective, minimizing costs across the firm. This is typically done in accordance with other business initiatives. “When you have an unstable market situation, you want the ability to push a button to run multiple scenarios,” Boston Consulting Group's Hardik Sheth told The Wall Street Journal. “The ability to forecast and do so quickly is critical in such an environment … the traditional way of combating inflation is by controlling expenses."

3. Save money.



Even the smallest expenses can eat away at earnings and stunt growth, so every business owner should be aware of what they are. 

According to Konnect Agency CEO Sabina Gault, reducing discretionary spending is an obvious first step when there is financial volatility, either due to the economy or corporate deficiencies. “This is the time to re-evaluate your company policies for travel, per diems and office supplies,” Gault said.

“Most companies' highest expense after salaries is paying leases and bills for their office space. During a recession or other financial strain, look to see if you can sublease some of your space to offset those costs that must stay,” she added. Gault also advises investigating whether certain services, such as online advertising or other services, can be put off. 

4. Maintain low inventory.



It's time to assess your warehouse and evaluate how much money you have on hand. During a downturn, it will be considerably more challenging to get ahold of cash. Learn to be as lean as possible with your inventory, even if it means defying industry norms.

However, do ask yourself how much inventory is required to keep pace with demand. This may necessitate the use of more sophisticated surveillance tools, but the benefits in liquidity are worth it. “Supply chain issues continue to impact us through inflationary pressures, including labor and energy, among several other operating expenses,” Lineage Logistics CFO Matthew Hardt told Fortune.

5. Set money aside.



Business owners should follow the same advice in preparing for a recession as they do for personal finances. It's impossible to predict when your cash flow will run out or when banks will stop lending to you. Emergency backup funds are essential. 

Even a new firm should have a contingency fund in place. Save money in a separate account so that you aren't tempted to spend it on necessities. The size, volatility, revenue and margins of your company will all go into determining your target balance. Consider it a successful beginning if you have sufficient funds to cover costs for three to six months.

6. Manage debt wisely.



When money is limited, debt grows rapidly, so pay it off as soon as you can. Focus on paying off your highest-interest debt first. In addition, it's important to keep tabs on all of your debt relationships, including those with suppliers and consumers. “This is a good time to lengthen the maturity of your debt as much as possible and to think about issuing debt,” said Columbia Business School professor Charles Calomiris. After all, inflation over time will reduce actual servicing costs.

There is still time to avoid the domino effect of a recession, even if it is imminent. Either way, companies that are proactive in managing their finances will be well-positioned for success in the future.

Outsourcing CFO services can make a big difference



Consider retaining the services of an outsourced CFO to help navigate economic turmoil. These professionals can work with you to improve your business’s finances, operations and overall growth. The demand for on-call CFOs appears to have virtually doubled in the face of a slowing economy. Hiring a seasoned third-party expert service to handle your worries about inflation and recession can help you focus on running the business. 

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