Abelardo “Billy” Cortez l May 18, 2023 l Manila Bulletin
Recession is a sustained period of economic contraction, or negative growth, across a country’s economy. It’s usually described as a drop in GDP (Gross Domestic Products) lasting for at least two consecutive quarters. Recessions are a natural part of the economic cycle and are always characterized by a decline in production and employment including reduction in consumer spending. With less money in circulation, businesses will have less cash while the government will collect less taxes.
Inflation, on the other hand, is the rate of increase in prices over a given period of time. Inflation is typically a broad measure on the overall increase in prices of goods, or the increase in the cost of living in a country. Whatever the context, inflation represents how much more expensive relevant set of goods or services have become over a certain period. With expenses rising and profits declining, companies will always try to minimize overhead costs, and even reduce the number of employees, products, and services they provide.
Clearly, both inflation and recession put major pressures on a company’s cash flow situation particularly when a company can’t pay anymore its bills, damaged relationships with suppliers and customers. Moreover, if cash flow becomes severely constrained, the company may be forced to take on expensive unnecessary debts or even be forced to file for bankruptcy. But when corporations try to borrow funds, they will find out that lending requirements have tightened and interest rates have moved higher. Such is the harsh reality in today’s global business world that has become borderless through digitalization, and connected people more than ever before.
Even in the toughest environment, the importance of proper cash flow management particularly during economic downturns will help corporations weather economic storm and even emerge stronger.
Cash flow management is very essential in any economic downturn. The CEO must do a realistic assessment of the company’s current financial situation. How quickly are its cash reserves being used?
Identify all cash inflows and outflows and check how long it will take to convert revenues into cash flows. He must review expenses and single out areas where costs can be reduced or eliminated. He must ensure that cash flows are used wisely and that they have enough cash on hand to pay bills. He must also keep a close eye on accounts receivables, spend less on inventories to avoid tying up your cash and reduce storage costs; equally important, he must maintain strong relationships with their suppliers. Of course, never forget, the CEO must tell the staff continually that you believe in them and expect them to
do well. It builds trust and loyalty.
The best way to manage business cash flows is to use technology. Cut through the clutter. Assessing the amounts, timing, and uncertainty of cash flows, along with where they originate and where they go, is one of the most important objectives of financial reporting. It is essential for assessing the company’s liquidity, flexibility, and overall financial performance.
There are three critical parts of a company’s financial statements: The balance sheets, which gives a one-time snapshot of a company’s assets and liabilities; the income statement, which indicates the business’s profitability during certain period; and the cash flow statement, which acts as a corporate check book that reconciles the other two statements. It records the company’s cash transactions (the inflows and outflows) during a given period and shows whether all revenues booked on the income statement have been collected.
If you ask most analysts, they’ll tell you they always look at free cash flow to understand better the true cash generation capability of a business entity. FCF is really a useful measure of financial performance and tells a better story than net income because it shows the money the company has left over to be able to expand the business, or to pay dividends, or to pay off debt.
Now when investors say cash is king, it means strong cash flows of a business that allows it flexibility in regards to business decisions and potential expansions. “Cash is king” is also a phrase that refers to superiority of cash over other assets or forms of payment. As a part of any liquidity management, it is important not to let cash sit idle but rather be always invested so that, at least, returns must be equal or higher than inflation rate.
If an entity fails to keep on top of its cash flows, make no mistake about this, the ripple effect can be costly in terms of future business growth and stability.
*** Atty. Abelardo “Billy” Cortez is former FINEX national president and chairman of FINEX Foundation, former co-chairman of the Philippine Capital Markets Development Council and currently member of FINEX Ethics Committee. He is presently board director and executive committee member of the International Association of Financial Executives Institutes (IAFEI).