Budgeting During a Crisis
Updated: Apr 29, 2020
In an alternative universe where #covid19 is the stuff of pandemic blockbuster movies, and our social media feeds still consist of an over-exposure of restaurant meals and holidaying happy snaps, organisations are busy preparing budgets and forecasts for the 2021 financial year, confident in their ability to accurately predict sales, capital and operating expenditure and cash flow for the coming year. The economic downturn resulting from the pandemic casts a shadow on all prior assumptions and organisations need to amend their calculations accordingly.
Here are some tips to ensure financial projections remain realistic, and Executive and Board decision-making takes into account current market conditions.
1. Identify business impacts on the following areas
Sales projections during economic downturn and measures to increase online presence if possible
Staffing projections including critical personnel required for business continuity
Suppliers ability to deliver and impact on production due to potential supplier restrictions
Financial impacts including ability to pay creditors and expenses, and requirement to draw down on cash reserves to survive the current climate.
2. Undertake a financial health check using the following ratios
Current ratio measures whether there are enough current assets to meet debts due.
Current ratio = Total current assets
Total current liabilities
Generally accepted ratio is 2:1 but varies by industry and amount of cash reserves.
Quick ratio excludes stock which could take some time to convert to cash, and is one of the best measures of liquidity.
Quick ratio = Current assets – stock on hand
Leverage ratio indicates the extent to which the business is reliant on debt financing versus equity to fund the assets of the business.
Leverage ratio = Total liabilities
The higher the ratio, the more difficult it would be to obtain further borrowings.
Debt to assets measures the percentage of assets being financed by liabilities .
Debt to assets = Total liabilities
In most cases should be less than 1, indicating adequacy of total assets to finance all debt.
Gross margin ratio measures the percentage of sales dollars remaining after cost of goods sold to pay overhead expenses.
Gross margin ratio = Gross profit
Balance sheet ratios:
Return on assets measures how efficiently profits are being generated from business assets and the ratio should be compared with the industry average.
Return on assets = Net profit before tax x 100
Return on investment measures the gain or loss generated on an investment relative to the amount of money invested, and is usually expressed as a percentage.
Return on investment = Net profit before tax x 100
3. Perform a budget recast
Identify and incorporate revised assumptions based on the business impacts identified earlier. Scenario modelling may include a 50% reduction in sales, supply chain price increases as well as potential government stimulus injections.
4. Prepare a cash flow forecast
Identify cash inflows and outflows based on the budget recast and take action to improve cash flows to mitigate risks of forecast cash flow crisis.
Measures include management of stock, expenses, debtor terms, supplier terms and assets.
For assistance in navigating #covid19 and the financial implications for your organisation, please reach out to our experts at exec wise.