Cash management - why it matters more than ever

We have labeled the “team” as the author. And while the people at BC Consulting strongly believe in individual contributions and responsibilities, this blog article really was a team effort. We, therefore, label it as such.

Posted by Frank BroerOctober 1, 2024

After 3 years of Covid-19, and fallout from Russia’s attack on Ukraine continuing into 2024, we are convinced that Germany’s economy will slide into a recession in 2025. We believe that the same is true for the global economy. And we are not convinced that the recession in Germany will be milder than elsewhere. High exposure to the energy crisis caused by Russia’s attack on Ukraine and corresponding inflation is raising costs, hurting demand, and eroding profits of companies in Germany more than in other countries. For many players in Germany, this is already the second time in three years when active cash (and cost) management becomes imperative.

The coming recession is coming may be deeper and longer in Germany

The war in Ukraine is widely expected to push Germany into a recession in 2025, as rising energy prices put a damper on industrial production and inflation means citizens will buy less. With a bit of Schadenfreude, some point out that this is the result of many wrong decisions Germany has taken over the last 20+ years. True. Russia had supplied >50% of Germany’s natural gas before the war, creating a correctly criticized dependency. Many observers now fear that gas shortages will hit key industry sectors in Germany such as chemical companies much harder, and will also hurt private households due to natural gas being the dominant energy source for heating. The spike in energy prices has led to double-digit inflation rates and will cause Germany’s gross domestic product to contract by 1.75% in 2023 (IW).

How deep and long this recession will be is hard to predict, as it depends greatly on the outcome and duration of Russia’s attack on Ukraine. However, comparisons with the aftermath of the oil shocks in the early 1970s resonate. Now and then, we are in the middle of an energy crisis, a negative supply shock, the return of inflation, geopolitical tensions, as well as resource competition. And high energy prices are already beginning to bite into companies’ investment plans and curtail production in Germany, raising the specter of de-industrialization in sectors like chemicals.

Active cash (and cost) management imperative

For many companies in Germany, this is already the second time in three years when active cash (and cost) management becomes imperative. We believe that many companies will also have to adjust strategies to deal with persisting inflation, and look for growth in more granular clusters while pursuing selective M&A opportunities. However, restructuring costs ideally before a downturn, and diligently managing liquidity and balance sheet are typically items that differentiate successful players in a downturn.

Cash and cost management along different timing horizons

We believe that in times of crisis, it is useful to look at both cash and cost improvement levers, and along different timing horizons: Improvement measures with impact in the short, medium, and long-run allow to build a portfolio of prioritized cost/cash measures based on the type and size of impact as well as on feasibility and urgency:

Short-term: Depending on the starting situation, short-term improvements may be mere sanity measures. However, for more cash-constrained players, startups and companies without access to additional external financing, short-term cash (and cost) management initiatives will be “must-haves” to stop the (cash) bleeding. We often find quick-win liquidity measures in this category, while pulling cash-cost levers that can be implemented in days rather than weeks. Such as hiring freeze, project stops, the reduction of certain employee cost (as well as perks and benefits, travel, training etc.) and other measures that can be fast-tracked
Mid-term: Typically, the mid-term measures include a more structured approach to “trimming the fat while preserving the muscle”. We often include a 360-degree, “zero-based” review of all operating cost, including all labor cost – While best avoiding a “burn-the-furniture approach”, e.g. in R&D. Also, some structured liquidity and balance sheet optimization as well as revenue “full potential” measures are feasible in the mid-term.
Long-term: These include pricing and revenue measures, zero-based cost management, as well as structured measures in cost management such as outsourcing, redesigning processes and automation

Definition of baseline (starting position and BAU-forecast) required

When cash is tight and the outlook uncertain, “muddling through” is not a suitable strategy. While avoiding “analysis paralysis”, a minimum of structure, analytics and planning is necessary to determine:

The precise starting position to understand how much free cash is really left and how much of this is “earmarked” for existing commitments
The magnitude of the cash/cost problem, including an outlook for the next 6-18 months in a “business as usual” baseline case, as basis for fast-paced scenario planning

Therefore, in our “cash lab”, we typically start with a liquidity forecast and estimate the funding gap to manage uncertainty with the following 3 steps:

Assess the level of accessible (“free”) cash
Calibrate minimum cash levels to avoid default
Project cash flows, develop cash scenarios and identify potential funding gaps

We Identify all current available sources of net cash and determine cash position, including accessible credit lines. We determine the minimum cash buffer level (‘net cash margin’) required to maintain operations and avoid default. And we analyze the degree of cash position volatility and seasonality as well as main drivers in a scenario-based plan. For some clients, it is also necessary to review covenants in financing agreements to avoid default. The projection of future cash flows in different scenarios over the next 6-12 months, with frequent (often daily) updates is the next step, accompanied by “stress-tests” for down-turn and worst case scenarios. If necessary, e.g. for startups and scaleups, we determine the cash runway based on our forecasts for the cash burn rate and available cash, and start refinancing (where necessary and feasible) as early as possible.

However, external refinancing is not feasible for everyone. In any case, it is advisable to focus on internal cash levers and only rely on external financing where necessary. The general focus areas along the three time-horizons were described above, including cost and revenue management as well as (working) capital productivity improvements.

Rigorous program management required

Last, but not least: Cash and cost management are only 10% analytical firepower and 90% execution, requiring a lot of discipline throughout the entire organization, but especially in the finance department. A lot of the cash lab requires working outside the comfort zone of each function. Which is not everybody’s favorite thing. It still must be done.