Tangled up in Corona

How CFOs proactively position their companies against financial distress and the threat of insolvency.

In the case of raw materials, shortages and price increases go hand in hand, and the effects have a direct impact on the operating result. The availability of semiconductors - incidentally a homemade problem of the automotive industry - continues to be inadequate. Those who have built up stocks in time and have been lucky in their choice of components can look forward to the current developments with greater peace of mind, because the increased material and special freight costs will have less impact on profitability. Vulnerable supply chains and out-of-control transportation costs remain an additional problem. And I don't even want to mention the embarrassing helplessness of the responsible politicians in dealing with the pandemic and its unpredictable consequences here.

At the same time, corporate balance sheet debt has reached record levels. So the next drastic decisions won't be very long-awaited.

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The CFO as navigator through the crisis(es)

Against this backdrop, I thought I would look at the above situation from the perspective of the Chief Financial Officer. As a rule, the work product of a CFO financially maps the events of a company that lie in the past, the look in the rear mirror. Nonetheless, the same question comes up again and again in my conversations with CFOs, namely: what overarching principle can help us as a company cushion negative shocks in the future?

In the following, I refer to companies in the mechanical and plant engineering sector, the automotive industry as well as the associated industrial sectors. After all, there are obviously also profiteers from the Corona crisis who emerged from the crisis as winners. Simply because their products filled the gap in demand created by the crisis. These include, for example, manufacturers of equipment for the construction industry, forestry, gardening and landscaping, DIY supplies, and medical and laboratory technology.

Let's first take a look at the measures taken by the companies that came through the corona crisis unscathed: The first thing that stands out is intact management with transparent communication structures. Open communication also means respecting employees as people and focusing on them as the driving force behind the company's success. In my experience, this is a major success factor in itself, especially when companies are facing major upheavals and difficult situations. Another characteristic is the definition of the business relationship with the customer. By this I mean no longer living the customer as an untouchable "sacred cow" protected by the company's own sales department, but as soberly specified by financial accounting: as a debtor.

Companies that have made this paradigm shift find it much easier not to offer every project with a bet on the future, to demand long overdue payments for changes, tools, etc. more vehemently, and to renegotiate prices in the worst case.

Finally, what strikes me about the "winners" is that their management understands the business intimately and is constantly evolving it. This includes constantly questioning themselves in the course of this continuous improvement, analyzing facts, evaluating situations. You might think that this is all self-evident. Unfortunately, far from it!

How does the CFO view the current situation? What will he do when the Corona crisis seems to be over and now the next impact is looming? How can the CFO and his team, together with the rest of the management, proactively make the financial performance crisis-resistant, especially to prevent financial distress in crisis situations? And how can companies be spared a restructuring by the banks and, in the final stage, agony in the form of an inability to service capital?

Stress test permanent insolvency audit

For liability reasons and in order to proactively counter a crisis situation, two measures are indispensable: the permanent insolvency check and, in particular, the permanent view of liquidity with the so-called rolling 13-week plan. Keeping an eye on all balance sheet ratios on an ongoing basis and recognizing all warning signs early on in the event of negative developments is the be-all and end-all for risk management in all finance departments. Rolling and detailed liquidity planning over a period of 13 weeks is a common tool for identifying impending insolvency at an early stage. Companies thus get "sufficient" reaction time when an acute shortfall is actually imminent. According to Section 15 of the German Insolvency Code (InsO), companies are obliged to file for insolvency if insolvency is expected within three weeks. Companies that are over-indebted due to the pandemic have also been obliged to take such a step again since May 31, 2021.

This does not have to happen under any circumstances if the future of the company and thus jobs are to be secured. The starting point for liquidity planning is to compare available liquid funds with current liabilities. Under the financial status, liabilities due, account balances, cash on hand and available current account lines are recorded. If this results in a positive financial status, there is no threat of acute insolvency. The next step is to determine the permanent willingness to pay, which requires the use of the coverage ratio. The coverage ratio provides information on the ratio of available liquidity to current liabilities and should always be above 100%. A coverage ratio below 100% threatens insolvency. In addition, companies must calculate the constant changes in liquidity. The basis for this is the net cash flow from the incoming and outgoing payments due over a period of 13 weeks. A rolling weekly update of this kind makes it possible to compare the actual situation with the planned liquidity in a timely manner - and thus provides the basis for adjustments in financial planning. If a shortfall threatens, CFOs must take working capital measures and, under certain circumstances, initiate external financing via banks or capital providers.

Toolkit for proactive crisis prevention

Of course, there is no master plan for managing financial distress, because each situation must be analyzed individually. For my esteemed Excelliance colleague Norbert Korn, a balance sheet expert and bank manager with long international experience, the following proactive measures have proven to be a compass for CFOs to put their finances on a stable footing for the long term:

- Sound preparation and regular updating of a rolling - 24-month - liquidity plan.

- Establishment of efficient working capital management with the aim of reducing tied-up capital.

- Optimization of maturity matching via medium- and long-term financing of the working capital base in order to reduce the refinancing risks existing outside the Corona assistance loans.

- Optimizing the capital structure via the right mix of senior and subordinated debt and strengthening the equity base to avoid accumulating too much "license to kill" debt on the balance sheet.

- Hold early bank discussions to ensure that debt providers are ready and willing to refinance any repayment obligations that are due but not covered by operating cash flows.

In my opinion, it is crucial to think outside the box in this regard as well: Because banks are themselves in trouble in some cases and no longer go along with every course of action. We are in an extremely tense situation, and the market is reorganizing. This should also be taken into account when considering refinancing.

I cannot emphasize this often enough: The expertise of a CFO and his team is demonstrated by interpreting crisis signals realistically and promptly. This includes processing the information and data situation transparently for all those involved and always keeping it up to date. Involving external specialists often broadens the perspective to better assess the real situation. Ultimately, a competent CFO is characterized by the ability to recognize a dangerous situation early on from the available figures and to use them to determine the right course for stormy times.

The author Rüdiger Tibbe comes from a family business in the automotive industry and also brings his vast experience at senior management level of large listed companies, especially in the manufacturing sector. He is Senior Partner and Managing Director of Excelliance Management Partners GmbH in Grünwald near Munich and, together with his team, supports companies as a body on the board of directors/management or on the supervisory board/advisory board. Since 2001 and well over 150 projects, Excelliance as an Industry Taskforce has developed over the years in the areas of transformation and turnaround management with its highly specialized, internationally active industrial and financial experts into a reliable size for medium-sized (family-owned) companies as well as listed large corporations.