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Thinking through your financials during the COVID-19 pandemic

Updated: April 2, 2020

There are a lot of useful resources out there that focus on how businesses should adapt to counter the effects of the COVID-19 pandemic. The purpose of this article, however, is to turn your attention to the financial aspects of your business that should be reviewed.

Normally, when starting a financial review or putting together a forecast, you start with revenues at the top of the income statement and work your way down through sales costs and overhead expenses. In these unique times, it’s better to flip this approach and focus on expenses first and speak to revenues second. This is because companies have greater certainty when it comes to expenses; revenue streams are very uncertain in the current climate.

Your objectives right now should be twofold:

  1. Determine the outlook for future cash flows coming into and going out of the business, and then calculate your company’s projected cash runway.
  2. Create a sound action plan given your outlook.

Expenses

Probably the single most important thing to understand about your historic and future expenses is the split between fixed and variable expenses.

Fixed expenses are items such as payroll (more about that later), rent, automotive leases, insurance, etc. that your company is required to pay out regardless of level of business and that do not vary with level of business.

Variable, or discretionary, expenses are items that can be “turned on and off” depending on the economic outlook and prospects for the business. These are things like (most) advertising and marketing expenses, fees for professional services (legal and accounting), travel, subscription services (such as Dropbox, Zoom and so on) and discretionary bonuses. These variable expenses demand the most attention during the review process.

Your starting point should be to assume that you no longer need variable services and, as a result, that those expenses can be eliminated. Some expenses don’t fall easily into these two buckets; for the purposes of this exercise, though, it’s useful to think of expenses in this way.

Approaches for Fixed Expenses 

  • Wages, payroll and ancillary expenses — such as Employment Insurance (EI), Canada Pension Plan (CPP), benefits and the processing costs associated with these — deserve the most attention from you. Remember that your top priority is to take care of your people and community; therefore, before you step into layoffs or other options to minimize cash outflow, consider other workforce planning and temporary reductions options. Left with no alternative, you should think about how you can legally minimize cash expenses under this category. Some options are trimming your head count, asking your employees to defer a portion of their pay or accept equity in lieu of cash or, if it is practical, asking company founders to take the lead and set an example by reducing or eliminating their wages first.
  • Rent is also a large part of fixed expenses. Your first steps are to check the expiry date on your lease and begin conversations on your cash-flow challenges with your landlord. Then review the trial balance for any expenses associated with storage or other locations you no longer need.
  • Review your aged accounts-payable list and prioritize which vendors need to be paid prior to other vendors. The objective here is not to make “vendors your lenders” but rather to organize and prioritize your outflows. Remember to be empathetic; your suppliers will be facing the same cash-flow challenges during these times. Review every major expense line item and decide whether there are alternative suppliers that can provide services to you, especially for those services that are mission-critical.

Revenue

The COVID-19 situation will have at least two major impacts on revenue and cash-flow receipts: new sales will be harder to come by (or non-existent), and existing customers will be slower to pay your invoices. Depending on your revenue model, as part of the sensitivity analysis outlined below, you should review what your financial forecast looks like in the following scenarios:

  1.  Collection of current accounts receivable and no additional revenue coming in
  2.  Collection of current accounts receivable and only currently contracted revenue coming in
  3.  Somewhere in between numbers 1 and 2

As a baseline, your analysis should follow these guidelines:

  • Assume the impact of COVID-19 will be felt for X number of months and will result in Y% of normal business.
  • Assume, in all scenarios, that there will be limited new sales over the next three to six months.
  • Review any results during an extended slower period of activity (some predictive models indicate there will be impacts for the next 12 months).

From a practical perspective, get invoices out quickly after services are provided, and keep an eye on accounts receivable aging and concentration. Try some of the following tactics to keep cash flowing in: offer an early payment discount to your customers, offer a discount for committing to a full year’s worth of services and transition customers paying by cheque to wire or Automated Clearing House (ACH) Network payments.

Decide what to do with payments that customers have made prior to a product or service being provided. This deferred revenue is a liability for the company, which is required to deliver the service. You may choose to provide the product or service as planned, refund the customer’s money or extend credit for future work.

Government of Canada COVID-19 programs

While not strictly revenue from an accounting perspective, any government payments — such as Scientific Research and Experimental Development (SR&ED) incentives, grants and HST/GST receivables — should be filed and accelerated. Take advantage of the recently announced Government of Canada COVID-19 programs, particularly the 10% wage subsidy and the new 75% emergency wage subsidy and the work-sharing program. In addition, there are provisions to delay payment of income taxes (though not GST/HST or employee remittances) and improve credit access in order to boost liquidity.

Tying it all together and final thoughts

Once you have completed an analysis of historic expenses and revenue items, it’s time to pull the revenue and expenses together and prepare a cash-flow forecast. It should start with the current cash balance and model the cash inflows and outflows, at least on a monthly basis (and, possibly, on a weekly basis) to determine your company’s burn rate and establish a realistic cash runway. While they’re not classified specifically as revenue or expenses, any sales of redundant assets or capital-expenditure plans should also factor into this cash-flow statement.

In addition, depending on your company’s age and stage, it is often useful to calculate a break-even level of revenue. In other words, with expenses pared down to the bone, what level of revenue is required to have enough gross profit (revenue less variable expenses) to cover the overhead (fixed) expenses?

A sensitivity analysis should be an integral part of your forecast, because it will allow you to see how varying certain assumptions will affect cash flow. Variables to test may include lengthening accounts receivable collection periods, lengthening accounts payable payment terms and taking into account changes to foreign exchange rates (the Canadian dollar slipped to $0.69/$1.45 these past weeks, so what happens to your business if that weakness continues versus if the rate bounces back to historic levels?). Focus on the downside, and be surprised to see the upside.

With this forecast in hand, you can have open and transparent conversations with your employees, senior management team, board of directors, major shareholders and financing sources and creditors. The purpose of these conversations is to establish a realistic operating and financing plan that will allow your business to weather this economic downturn. Your bias should be toward acting sooner rather than later and considering larger implications to your business versus smaller implications.

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