Whatever the eventual details and impacts, businesses need to treat Brexit like a recession.
It demands the same kind of forecasting, planning and scrutiny of every aspect of operations and their costs - and, ultimately, offers the same threat and opportunity: those companies who survive the transition will be stronger for it - because of this rigorous self-analysis, the purging of the inessential and protection of what matters most.
So the first step for finance executives is a forecast, particularly of what cash flows will be over the coming period. Typically, a rolling 13-week forecast will be useful, and include an income statement (profit and loss account) and a balance sheet. Clarity is key in our uncertain environment. The board and senior managers need to understand exactly what the assumptions are, how they have been arrived at, and have the chance to provide input.
The forecast will be wrong - that’s just the nature of forecasts, no-one knows what’s going to happen. You need to be looking at a suite of potential scenarios for Brexit, and prepare a sensitivity analysis that sets out what might happen in each instance - in terms of issues like a disrupted supply chain, currency value and tariffs - and the implications for finances and how the company can respond. This provides a spectrum of financing needs and a basis for an action plan. Inevitably the scenarios won’t pan out exactly the way you think, but the thinking process in itself will give you a great advantage in being able to respond to whatever situation does materialise.
Other financial preparations are more straightforward but just as essential. You’ll need the right paperwork: all importers and exporters need an Economic Operator Registration and Identification number (https://www.gov.uk/eori); and make sure you’ve signed up for the Transitional Simplified Procedures system for exporters, allowing you to also delay some duty payments (https://www.gov.uk/guidance/transitional-simplified-procedures).
Don’t get distracted
Uncertainty doesn’t excuse a wrong-headed financial strategy. The fundamentals are more important than ever; meaning that financial strategy needs to be tailored to suit business strategy and the stage the operation has reached in its life cycle.
We all understand that different companies have different strategies and customer propositions. For example, If I go into Aldi and I’m not able to find what I’m looking for, I see that as it’s my fault for not getting there sooner - they’ve run out of that deal and it’s my loss. But if I’m in Waitrose and they’ve run out, they’ve failed me as a customer. That’s the difference in the two retailers’ positioning.
Market positioning and relationship with customers needs to be backed up by the finance model. So if the business sells itself as delivering a higher quality offer, finance needs to be available to spend on stock, more needs to be put into offering better credit terms. And at the other end of the market, where profit margins can be small, the model needs to be based around ensuring the ongoing high volume of transactions.
Surprisingly this integration of strategy isn’t always considered. Finance professionals can sometimes hold to general principles of reducing investment: holding as little working capital as possible, reducing inventory and debtors. For companies that promote themselves as high quality and value, stock-outs or poor credit terms can result in losing customers.
The four strategic decisions
In the context of Brexit, there’s the need to keep the long-term strategy in mind, to protect the core of what makes the business what it is, and the relationships that go along with it. With increased risk comes the need for more focused attention on financial strategy decision-making. There are four strategic decisions to be considered:
- How much should we have invested in our asset base?
- How should we finance this – what proportions of debt and equity?
- How much profit should be paid out in dividend?
- Should we (and could we) issue new equity?
Financial strategy must be managed against the business risk. Risk changes over the company’s life cycle. A new enterprise has high potential for growth, but it needs all of its cash for reinvesting in the business, so it can’t pay dividends. Furthermore, it isn’t in a position to borrow because it can’t know how it’s going to be paid back. So it seeks longer-term venture capital. One the other hand, a mature company can’t offer substantial growth prospects for investors, but needs less investment, so can pay them dividends. In other words, the financing strategy and the dividend payout strategy needs to be in line with the stage reached by the business in its life cycle.
Our work in this area at Cranfield is one of the areas explored within the Finance for the Boardroom programme - one of our specialist programmes designed to develop appropriate skills for non-financial professionals and frameworks to successfully improve financial performance and shareholder value in your organisation.
Blog produced by: Professor Ruth Bender, Emeritus Professor of Corporate Financial Strategy and Programme Director of Finance for the Boardroom, Cranfield School of Management