"It’s not the strongest species that survive, nor the most intelligent,
but the ones most responsive to change.” - Charles Darwin
What a year. All of the (family-friendly) adjectives we might use to describe 2020 seem inadequate. Few people were sorry to see the year come to an end, but there is something business owners, CFOs and managers can be thankful for when looking back on 2020 – it was a great reminder of how important it is to be adaptable when the unexpected occurs, and that preparation can be the difference between survival and ruin.
It also reminded us that while we cannot anticipate what form the next crisis will take, it is safe to assume it will not look anything like this one (remember the 2008 Financial Crisis? It had almost nothing in common with 2020). So, being prepared means preparing for whatever might come next.
In this article, we discuss how to ensure your business is as prepared financially as it can be for the next crisis, so that you can respond from a position of strength and take advantage of opportunities to turn lemons into lemonade.
That means being agile and flexible in making quick adjustments, perhaps even pivoting in a new direction. It also requires a solid understanding of your company’s financial condition as it stands right now, and having a solid cash position to weather storms.
10 Financial Strategies for 2021
To ring in the New Year, we rolled up our sleeves (we’ll keep them rolled up for our vaccine) and identified ten key financial lessons from 2020 that we believe are critical for business owners as we begin 2021. Here’s to turning battle scars into tools that will help in any future business challenge.
1. Adaptability and flexibility are critical to surviving a crisis and to uncovering opportunities.
Successful companies have the data, systems and technology they need to make informed decisions, rather than seat-of-the-pants guesstimates, and a culture that allow them to adapt rapidly to respond when a crisis occurs.
A crisis does not have to be global in scope; it could be as “local” as having a new, formidable competitor launch a disruptive innovation in your market niche. Being adaptable and flexible requires you to evaluate your options based on clean data, market intelligence and a culture that encourages out-of-the-box thinking. It may sound like a cliché, but the idea that is shot down because “that’s not the way we do things” could be the idea that would have saved your business.
2. Having a strong balance sheet buys time.
This allows you to think more clearly and evaluate your options more objectively. In 2020, companies that had improved their balance sheets over the previous few years when the economy was strong were, on balance (pardon the pun), better prepared to deal with the pandemic than companies that had made excessive distributions to investors, or had taken on too much leverage as a way to address working capital problems. As a general rule, a profitable business should aim to have enough net cash on hand to cover three to six months of operating expenses.
3. Know your customers, know why your products and services are valuable to them, and know their financial condition.
If the economy goes south, which of your customers are likely to struggle to pay their bills? Stay in touch with them, even in good times. If possible, know your customer’s customers, as they ultimately affect whether your customer pays you. You might even be able to help your customer serve their customers better – a win-win.
4. Know your vendors and their supply chains.
Are they ready, willing, and able to support your growth or to be accommodating if necessary? Do you have back-up vendors for key inputs and are they in a different region than your primary source? If a natural disaster strikes, or a political strain leads to tariffs or import restrictions, it does you no good if your back-up is in the same situation as the supplier that has been “disrupted”.
5. Know your capital providers.
Talk with your lenders, investors and shareholders regularly. Keep them informed, share your plans, and know their concerns and hot buttons. The best policy here for everyone involved is “no surprises.” That way, if there is bad news to deliver you have built up a foundation of credibility and information that can be important in deciding how far they are willing to go to support your business. In addition, assess your lines of credit and work to expand them when the business is doing well. That does not mean you intend to draw on those credit lines, but having them in place can be a critical buffer in rough times.
6. Prepare for a variety of situations and outcomes in advance.
That preparation becomes a resource you can draw upon when a crisis arises. To assess whether you have done adequate prep work, ask yourself the following questions:
- Do you have a budget, and have you stress-tested key inputs to that budget to assess the impact on cash flow? For example, what would happen if revenues declined by 30% in three months? What if it took 75 days instead of 45 days to collect your receivables? A year ago, you may have thought these scenarios were too extreme to consider but 2020 taught us they are all too possible.
- When evaluating new initiatives (expanding a product line, offering a new service, moving into a new region, etc.) have you distinguished between must-haves and nice-to-haves, based on a thorough market analysis? When a product manager says “it has to include X, Y and Z” and Finance says, “it won’t be profitable if we do that,” making informed decisions based on data, not opinions, avoids spending money on nice-to-haves that customers may not be willing to pay for, or building a product that flops because it lacks important features.
- For both Business As Usual forecasts and in evaluating the viability of a new product or service, have you considered three scenarios: Base Case, Best Case, and Worst Case? Identify how you could cut costs and scale back if the Worst Case were to come to pass so that if it does, you are ready to act.
- Have you identified your top employees, the ones you really rely? Include your most effective revenue-generators, of course, but also your best programmers, client support personnel, team leaders, etc. If (when) another crisis hits, employees are likely to worry about job security; you will want to be proactive to retain the ones that matter the most.
7. Cash remains king.
Not just cash on the balance sheet, but also cash flow. Cash is like a life preserver that can keep a business afloat until a crisis passes. Conversely, cash flow problems can push business owners to take drastic measures to stay alive that can hurt the company long after the crisis has been resolved. Companies backed by venture capital or private equity that are burning through cash should initiate a new round of fund-raising when they have about nine months of burn on hand.
8. Capital seeks quality companies, even in stressed environments.
While deal-making paused during the initial shock of the pandemic (Q2), it had recovered to fairly normal levels by the summer of 2020. However, not all types of companies were involved; while there were still “typical” deals, most of the activity was seen at the extremes in terms of quality. High-quality, well-run companies achieved premium valuations and troubled businesses were forced to sell at “bargain” prices.
9. Risk involved in M&A during a crisis can be mitigated.
Transactions in 2020 often required more structuring to get the deals across the finish line, and in-person due diligence was challenging, but people found ways to overcome the hurdles and mitigate risks. Going forward, know that a crisis does not mean there is too much risk for transactions to proceed; it just means the deal may have to be structured in a way that accounts for the uncertainty.
10. Sustainability matters.
Companies that generate recurring, predictable revenue are always appealing to potential investors. As we saw in 2020, even in times of crisis M&A activity continues and businesses with solid revenues and good cash flow can achieve attractive valuations. A number of companies experienced a “COVID lift”, with revenues boosted by consumers working from home, schooling at home, eating at home, etc. The challenge for companies and investors is to determine the extent to which that boost can be sustained. When new sources of revenue that arose from pivoting during a crisis are retained after the crisis is over, the company has turned lemons into lemonade.
It is said that experience is the toughest teacher; she gives the test first, and then explains the lesson.* We think that sums up 2020 quite well. G-Squared Partners helps companies to apply these lessons in a practical, hands-on way so that when the next test comes, they are well prepared. To learn how we can help your business, please contact us today.
* We would like to give a shout-out to all of the teachers who have made heroic efforts to keep students engaged with remote learning this past year.