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.

 

  1. Assess Sales Scenarios

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.

 

  1. Assess Direct Cost Structure

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.

 

  1. Assess Sales and Overhead Cost Structure

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.

 

  1. Compile Full P&L 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.

 

 

  1. Plan and Prioritize Cost Cuts

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:

  1. How profitable the business is currently, and how far sales would need to decline in order to lose money
  2. How much cash reserve the business has
  3. How confident the business is in its sales forecasts and resulting P&L forecasts
  4. How much tolerance ownership has for losing money, including its ability to forego pay for some period of time and to contribute more capital to finance the business’s losses

 

Additional Details

For more detailed information, please view the original article on the SmartBooks website.