How to prepare the economy of a company to face an economic crisis?

Part I

Given a more than possible economic recession in the Eurozone in the coming quarters or, at least, a GDP of around 0%, it is very important to take into account the potential effects that a slowdown in the economy may have on the finances of your business.

At Augé Holding Group, as a result of the constant consulting on accounting, economic, tax and business planning matters to our clients, we regularly observe a repetition of the same mistakes in the management of a business. These errors can contribute to granting little room for maneuver to employers, condemning them to a policy of forced layoffs, reduction of value-added operating costs, reduction in the quality of the service or product and a long etcetera that can lead to the worst consequences.

For this reason, in this Newsletter (the first of this edition) we present the first basic practical advice to be able to control and properly reconstruct the processes and finances of your company: 

  1. Initial financial analysis

First of all, we must know at what stage we are. As an entrepreneur, you need to analyze whether each of the compartments, sections, work areas, departments, etc. of your company are duly reflected in your accounting at an analytical level. In order to be able to determine the segmented performance of each of your productive areas, you need to carry out a detailed allocation of income and expenses and appropriate to the needs and reality of each section.

For this reason, when you begin your analysis, do not forget to divide up the different areas of your company since you will be able to study the individualized performance of each service or product much better, or eventually of each worker and even of each operating cost charged to said area.

On the other hand, it is necessary that you analyze all your cost centers (or non-productive areas) in order to appropriately pass on to your productive areas the proportional parts of the use of said costs. In this way, you will be able to clearly identify if there are superfluous or unnecessary costs, as we will discuss later.

And besides that, you must identify the origin and volume of diversification of your sources of income to be able to use the financial data in your present and future commercial policy. In addition to an examination of the income and costs of your company, you should not forget to carry out a study of your cash flows, since the health of your treasury is the basis of the subsistence of your business. 

  1. Recurring study system of a treasury

At this point, we always recommend trying to build tools (metrics) that make it possible to identify the differences that exist between an accounting expense and a capital outflow, and an accounting income and an inflow of capital. Almost no company collects 100% of its invoices at the exact moment that it issues an invoice or assumes its expenses at the precise moment that an invoice is received. Therefore, and in order to be able to know month after month if the state of your treasury is adequate, you need to build tools that are useful to you.

But how can we know what is the appropriate treasury level for a company? 

As logical, the employer must understand that the average cash receipts to which he must aspire have to cover recurring outflows (recurring operating costs such as salaries, fixed providers, electricity, rent, etc.) and leave, at least, a positive treasury margin month by month that does not ostensibly stray from the average operating margin of the business (since if it strays too far we may find ourselves facing a problem in the collection policy and its periodicity or in a situation of entrenched delinquency). 

Seasonal businesses or those that have a specific period of low cash inflows should work on strategies to avoid generating negative cash during such periods (otherwise, they would run the risk of entering a vicious cycle between “good” and “bad” months, reaching annual Cash-Flow averages close to 0 – win some, lose some -), although its operating account reflects a positive margin of 20% (which unfortunately never ends up existing in treasury). 

The monthly positive treasury, if it exists, must have a working capital vocation in the company’s own operating accounts in the event of any period of complication in the receipt of payments or in the event of any periodic slowdown in income. However, it should not be considered the reserve fund, which we will discuss next. 

  1. Reserve Fund

A reserve fund must not only be set up in every company, but there must be a very specific policy on the cases in which it is allowed to resort to it (since it can be confused with the day-to-day cash surplus in operating accounts, which we just talked about).

This liquidity fund must be nourished mainly by the monthly % of positive treasury that we determine, for example, a third of the monthly positive treasury, the entry of extraordinary or unforeseen income and the remainder that is desired to be allocated to reserve once the result of the financial year (provided that said amount exists in the treasury) is analyzed.

Ideally, a company should aspire to have a reserve fund that would allow it to cover 3 to 6 months of total operating costs, to guarantee that, in completely exceptional circumstances, economic slowdowns, market problems at a sectoral level, etc. essential costs could be covered. Assuming that in such periods the company would quickly seek formulas to lower its costs and to preserve a minimum of income, a reserve fund of this volume could help the business subsist for more than a year. 

Of course, the maximum and “less foreseeable” impact that we have just exposed helps us to calculate what the total or ideal volume of our reserve fund should be. However, to avoid the temptation to assume unnecessary expenses when there are surpluses (typical in times of abundance), or to carry out provisions that are not relevant or do not respond to the purpose of the company, there must be a specific policy that determines the only cases in which the reserve fund can be used (example: workers’ compensation, accidents, repairs greater than X value, judicial sentences, etc.), as well as a plan to refinance it each time the figure falls below the endowment objective of the fund.

  1. Elimination of unproductive costs

It is still surprising to see how the vast majority of companies lose money at the cost level. The lack of analysis of the productivity generated by each of the costs is one of the biggest condemnations for the financial health of a company.

Executing the approach that we are going to formulate is somewhat laborious, but eminently simple. Every company must list 100% of its costs and, for each of them, carry out a rating about its essentiality for the existence of the business (for example, the rent of the restaurant would have a rating of 10 out of 10). In this sense, all those costs that have been qualified, for example, below 5, should be studied. Not for the fact of determining, and if they are essential, but if they are productive. 

One of the biggest revelations that a businessman can have is to identify that a certain percentage of his company’s costs are sunk because they do not contribute to the concrete generation of income. Therefore, it is essential that, with the analysis of each cost, an attempt is made to generate a direct correlation with the type of income to which it contributes, both directly and indirectly. 

Once this cleaning has been carried out, your company’s monthly turnover will be healthier, and you can even consider assuming new costs as long as they can increase your operating margin and serve your cause. Many companies are not able to assume a greater cost that can generate added value to grow the business, precisely because they have not eliminated all those costs that have little or no positive contribution to the operating account. 

These are just some simple tips to start an optimization of a business economy, no matter which sector it belongs to. 

At Augé Holding Group we will continue to publish subsequent editions in which we present more advice so that your company can prepare for an economic recession or for adverse financial circumstances.