Current events highlight what many have been talking about for years with respect to risk and governance. Now is the time for leaders to take stock of what managing risk is all about and the board’s and executive team’s related oversight roles. The CFO and finance organization have an important role to play in this review. Recent disruption in the banking industry presents a wake-up call for internal and external stakeholders alike in companies outside of financial services.
To address questions and expectations of boards, senior leaders and other stewards of capital, here are five points for CFOs of non-banks to consider:
No matter what or how much is on the corporate agenda, leaders can’t take their eyes off the fundamentals of the business, its strategy and risks
Every CFO knows that liquidity is the lifeblood of the business. Now is as good a time as any for CFOs to assist their companies in aligning their cost structures in a rational, deliberate manner and improving balance sheet health to increase corporate resiliency and flexibility. In the current interest rate environment, it may not be possible to make bold adjustments over the short term. But plans should be developed nonetheless, even if they require time to execute.
In addition, the financial health of customers and suppliers should be assessed carefully to identify potential working capital trouble spots that may be festering. This assessment should incorporate a review of customer portfolios and supply chains for concentration risks that should be mitigated through diversification and other strategies, as well as how receivables and payables are managed. Financial projections should focus on monitoring and maximizing cash flow to increase resiliency. Operating plans should emphasize monitoring all elements of working capital. Efforts to raise liquidity, or maintain access to reliable sources of liquidity, should be proactive and intentional.
Take stock of banking relationships
Banking relationships should be examined to rationalize account structures, assess service levels, and review the reliability of credit facilities. This examination of the treasury function should consider the company’s strategy and cash flow requirements, including:
- The concentration of liquid assets and funding sources at different banks to ascertain potential concentration risks;
- The adequacy, availability and stability of revolving credit line structures, given the company’s working capital needs;
- Changes in business and industry trends, including peer comparisons; and
- Changes in bank policies, services and regulations.
Needless to say, relationship assessments should consider the health of the financial institution(s) with which an organization does business. This is easier said than done in the present environment. Traditional indicators used by treasury in performing these assessments in the past may not prove as useful in spotlighting the concerns precipitating the current industry disruption, e.g., comparisons of banks’ capital ratios and loan-to-deposit ratio in relation to other financial institutions and analysis of trends in a bank’s allowance for loan losses, net interest margin, return on assets and net income margin.
It may be more important and insightful to understand the percentage of the deposit base that is uninsured and assess the quality or relative riskiness of the bank’s asset mix, including asset (and depositor) concentrations and how they may be affected by current conditions. Another important consideration is the bank’s history and its communications of present and future plans and market focus. For example, has the bank grown rapidly in a short period of time? If so, where did it park the assets fueling its growth and how does that portfolio align with its liabilities (deposits)?
Given that questions are being raised in both the boardroom and C-suite, CFOs should jumpstart this review sooner rather than later.
Internalize and digest the consequences of the Fed’s hawkish monetary policy on the cost of capital
Fed rate hikes affect the entire capital structure landscape, from debt to mezzanine to equity financing. When the cost of capital — in whatever form — rises, the capital budgeting and allocation process is affected, as time horizons and internal rates of return are directly affected. These impacts spill over into the dealmaking process.
In addition, the current rate environment forces companies — particularly those that are highly leveraged — to take a closer look at aspects of the business that are interest-rate-sensitive. Failures to match sufficiently the maturity and re-pricing terms of assets and liabilities are compounded by leverage and can precipitate circumstances in which long-term fixed-rate assets must be sold at a loss. Interest-bearing assets are declining in value as the Fed raises interest rates at a historically rapid pace.
Reinforce confidence with investors, employees and customers that the business is on sound footing
In times of economic uncertainty, internal and external communications should provide clarity to educate customers, employees and shareholders about the fundamentals of the business. But CFOs should be mindful of the disclosure risks. If the business is doing well and its funding sources are stable and reliable, the message can be one of assurance. However, if there are issues and challenges, the message is one of straight talk. The message to customers and employees should be consistent with messaging to investors. This consideration is largely dependent on the industry.
If deemed appropriate, these communications should address the company’s liquidity and banking sources. Transparent communications engender confidence and preserve morale, particularly for employees. As a matter of perspective, most Millennials and all Gen Z employees did not experience the 2007-2008 financial crisis as adults. In uncertain times with some media commentators sensationalizing the news rather than sticking with the facts, no news does not necessarily equate to good news for these employees.
Manage margins and don’t forget the future
Research by McKinsey suggests that the revenue profiles of resilient and non-resilient companies are not much different during a recession. However, resilient companies differentiate in that they report margin improvements, whereas margins decline for non-resilient companies. Proactive cost management and a strong focus on managing leverage lead resilient companies into a superior liquidity position and enable them to exit tough times in a stronger position and maintain the liquidity to make key investments as they do so. Bottom line, CFOs should focus on margin management and encourage supporting those investments that can facilitate a springboard to recovery once the downturn ends.
Now is a time for CFOs and other leaders to tap the brakes on some of the “nice to have” discussions and instead focus on fundamentals and shore up confidence in the wake of recent events. It is also a time to revisit risk management strategies in rate-sensitive areas and the effectiveness of board and management risk oversight processes.
This article originally appeared on Forbes CFO Network.
