08/04/2020 The global economy is weakened due to Covid-19: supply chains are disrupted, and market and consumer confidence is undermined. As the consequences of the pandemic continue to occur, many businesses should expect payment delays, loss of revenue and cash shortfalls. Working in these uncertain times, the ability of financial models to forecast business downturns will serve their owners and managers well.
Industries are being affected in different ways: while some are losing business fast, others are in higher demand than usual. Take transport and domestic energy suppliers, for instance. While the former is hemorrhaging customers due to widespread lockdowns and social distancing measures, the latter is dealing with a change in distribution with large increases in home energy consumption but a reduction for industry. What is constant, however, is the need for financial modelling so businesses can anticipate risks.
How customer payments might change
Customer payments may change as a result of cash flow issues and affect an organisation’s sales ledger in many ways. For instance, the customer could pause payments with subsequent catch-up payments, or they might ask for a specific negotiated repayment schedule to give some confidence to both sides. There is – of course - also the risk that payments stop altogether, and the customer goes out of business, but we hope won’t be the typical case over the next few months.
Beyond disruptions to customer payments, businesses might also face bad debt or scenarios in which interest on balances is deferred or cancelled. All these payment interruptions – even if temporary – can impact businesses and put them at serious risk. Cash flow management will be key during the next months – so how can businesses deal with payment variations in a financial model for an operational project or ongoing business?
Financial modeling to anticipate risks
How to incorporate delays to customer payments in financial models depends on the methodology in the base working capital calculations and how those calculations respond to perturbations.
In this Excel demonstration, John Yelham, Director, Energy & Infrastructure at Mazars in the UK, explains working capital calculations and how to adapt financial models for some of the outlined payment variations. Firstly, he explains how payment disruptions affect the forecasts in two distinct types of working capital methodologies. Secondly, he demonstrates how to incorporate realistic circumstances into each working capital calculation. The scenarios include late payments, non-payments and a negotiated repayment schedule.
As Covid-19 takes its toll on the economy worldwide, a surge in insolvencies can be expected. While the circumstances are specific to each business and sector, financial modelling remains an effective tool for businesses to forecast scenarios and to adapt their planning accordingly.
As demonstrated in the webinar, keeping financial models flexible is an effective strategy. Fine-tuning models using well-structured manual adjustments for exceptional circumstances is preferred over introducing all variations as a calculation in the model (which are complicated and cannot possibly anticipate all variations). In doing so, businesses can react to their specific reality and, possibly, forecast a brighter tomorrow.