With calendar year 2023 almost halfway over, the three most common financial performance excuses lenders and company management are hearing relate to:
1. Covid 19.
2. Supply Chain.
3. Inflation.
Let’s look at each of these excuses as related to 2023 performance and consider how to deal with the real impacts on a business, without lumping performance excuses into a broad undefined category.
Covid-19
First, let’s understand that businesses have been impacted by Covid 19 – both positively and negatively. Consider these possible impacts related to Covid-19:
Some businesses were shut down and some were not. The duration of the shutdowns varied by industry and by state.
Some businesses lost employees or had to pay more for employees because government stimulus money made staying home easier for potential workers.
Businesses received liquidity via PPP loans, grants, ERC credits, and other programs. This liquidity allowed needed performance corrections to be delayed.
Customers changed buying habits.
Customer needs changed.
Supply Chain
Next let’s consider supply chain. Impacts related to supply chain include:
Trucking costs increased – fuel and labor impacted pricing, as well as availability of resources.
Container shipping costs increased by 10x. A $2,000 container in Q1 of 2020 became a $20,000 container in Q3 of 2021.
All other forms of freight also increased in cost.
Availability of goods was impacted. Purchase orders were not completed on time, and then multiple purchase orders were shipped at the same time. Inventory increased.
Supply chains are more normal now, but inventory levels increased, and the makeup of the inventory may not match current demand trends. Companies are working through excess and incorrect inventory.
Inflation
Inflation is a catchall for many items, including:
Cost increases for each line item in the income statement.
Rising interest rates impact financial performance.
Labor cost pressures are continuing as inflation outpaces wage increases.
Changing buying habits of consumers. For example, some companies are experiencing inventory valuation issues as customers are pushing prices downward because customers are switching to lower cost alternative products.
Everyone agrees businesses have experienced financial impacts tied to these three most common excuses. Many people have said the last three to four years have seen the most upheaval in financial performance experienced during their lifetimes. That is probably true, but business management is paid to navigate these problems and identify ways to improve performance. Companies and their lenders need to acknowledge these impacts are real but quantify the impact and develop a plan to deal with issues relating to performance.
What are some tools a business can use to better deal with the stresses?
Some suggestions to improve management’s ability to respond to the problems include:
Expand budget to actual performance analysis to include price/volume variance analysis for revenues and key expenses. Begin the analysis with 2019.
Prepare a common size financial statement analysis. For example, for a sawmill, prepare a common size statement per board foot produced. For a dairy, prepare a common size statement per hundredweight of milk produced, or per cow.
Update product profitability analysis.
Update customer profitability analysis.
Evaluate commodity pricing impacts on the cost structure.
Prepare a contract review including key contractual terms.
o Supplier contracts.
o Customer contracts.
Develop a working capital management plan.
o Evaluate sizing of the line of credit and key hurdles, such as maximum outstandings or relationship between accounts receivable and inventory.
Consider new shipping costs. Evaluate the risk presented by a potential West Coast dock workers strike.
Evaluate inventory aging and turnover by SKU.
Look at financial performance from 2019 through 2023 to evaluate areas where inflationary pressures on pricing have yet to be felt.
Consider the impacts of mark to market inventory adjustments, LIFO reserves and other inventory related accounting practices.
o Be sure to evaluate impact of these accounting entries on an ABL structure.
Evaluate all lending relationships for repricing risks.
Evaluate the 2023/2024 forecasts to ensure forecasts are up to date and consider the impacts of the analysis topics noted above.
Ideally a company has already completed the analysis listed above, but if not, it is time for senior management to assign the tasks to the accounting and finance staff, with deadlines for completion. Analysis and real time performance information are key to success in 2023 and beyond. Internal company resources may be stressed, or the type of analysis required may not be well understood by existing staff. Consider bringing in experienced people to prepare the evaluations, or to deal with solutions to the problems identified. The level of inflation and economic upheaval have not been seen for at least 40 years. Bringing in new resources will help a business understand performance, identify areas for improvement, and monitor performance to an improvement plan.
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