Due to the COVID pandemic, businesses are grappling with a high degree of uncertainty and fear about their revenue, profit, and cash flow for the next several months or longer. Most businesses face a decline in sales. Cash flow can be driven by diligent collections of accounts receivable, extending vendor payment terms, and accessing available borrowing options. However, in order to maintain or return to profitability, underlying cost structure must be addressed in addition to short term cash flow. Here we lay out an approach to modeling and managing through potentially large sales declines until economic activity recovers to a normal level.
Assess revenue streams overall and the risk that they decline. Also assess individual customers and the risk they curtail purchases. The more concentrated sales are to a small number of large customers, the more important it is to assess individual customer risk. Forecast a few realistic scenarios ranging from what would be a modest decline for you in sales from current volumes to what would be a large decline from current volumes.
Assess your variable and fixed direct costs of producing and delivering the goods and services you sell. An example of a variable cost would be a third party product that is resold. If there is no sale, there is no such cost incurred. An example of a fixed cost would be a salaried project engineer who provides services to customers. If there are no projects to deliver, the salary is still paid. Project those variable and fixed costs over your revenue forecast scenarios.
Look at your Marketing & Sales and General & Administrative expenses, and separate the fixed costs from the variable costs. Project those variable and fixed costs over your revenue forecast scenarios.
Compile all this data into a set of full P&L scenarios. This will paint the picture of your profitability at varying levels of sales decline. Here is an example of full P&L scenarios with a break-even around an 18% sales decline.
Because variable costs naturally drop when sales drop, cost cutting efforts focus mostly on reducing fixed costs. Current fixed costs were built up to support the company at its current volume levels, not a company producing significantly smaller volume levels.
Ultimately cost cutting is a matter of deciding which costs can be cut with the minimum impact on serving existing customers, “keeping the lights on” from an administrative perspective, and preserving the ability to bring in new customers now and in the future when economic activity picks up.
How aggressively to cut costs is largely a function of:
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