Economics and Business
Going with the flow
By Vivid writer: Ray Breden
In times of crisis, many companies are dropping their prices just to keep cashflow ticking over. When the recession is behind us, how will partners react to having the older, higher pricing restored?
Posted: 21/12/2009
A frequently heard complaint of business is that their need for support in a cash flow crisis is not being met by the banking system and ultimately government.
Obviously most businesses are finding life difficult. Some are suffering very badly. But when you look at what is actually happening, most if not all are saying that the main problem is cashflow. Customers are not paying their invoices on time, but businesses have an immediate need to pay salaries on time and also to pay their suppliers. This means that the potential outflow of cash is greater than cash received, and so business has a problem. A big problem. This may seem to be a statement of the obvious, but it is worth stating.
A general manager of a manufacturing company said to me that in his opinion the issue at the moment was survival. His company was having to deal with a drop in sales, having to wait longer to get paid, and having to deal with increasing pressure from suppliers to get their bills paid. It was essential for the company to survive and then to come out at the other end in reasonable shape.
This same manager said that in normal times most businesses could apply the "loyalty principle". If you had one customer who always paid on time but had hit temporary difficulties, then you could probably accommodate extended credit terms to see that customer through its bad patch. Once the customer got through this, it would stay loyal. However, these are not normal times. The general manager went on to say "I simply cannot afford to give extended credit to all of my customers, but I cannot afford not to. But the dilemma is that the crisis may damage the concept of loyalty. In future, no matter how understanding I am to my customers, once we are through the crisis they may switch to lower cost suppliers - even though their quality is worse - and my help to them at the moment could count for nothing in the future. I compete on quality - not price".
This neatly brings us to examine what I am being told about the way in which businesses are already restructuring. There is general consensus that Romania is behind Western Europe in the restructuring process, mainly because the effects of the crisis were felt later in Romania than elsewhere. Companies here are building their 2010 business plans on the basis of what is happening in 2009. A number of Western European companies restructured for 2009 because for them 2008 was a bad year. They are often budgeting for a drop in sales, staff cutbacks, but above all reducing or eliminating what they think are non-essential supplies and services. They are trying to negotiate (and often succeed) in getting cheaper prices. Very sensible, I can hear you say. But here is the concern of many that I have spoken to. Once the crisis has bottomed out, companies will be reluctant to expand if this involves an increase in costs. They are very unlikely to agree to go back to paying pre-crisis prices to their regular suppliers.
In other words, once out of the short-term crisis businesses may well find that they have a more efficient and streamlined operation, with acceptable and manageable costs, but also that their revenues have reduced to a lower level from which it may be very difficult to recover.
What could this imply? Up to the end of 2008 most businesses were budgeting for expansion, based on the experience of the previous three years where there was year-on-year growth in Romania. The situation has now changed. The consequences of having a more streamlined operation, albeit with lower revenues, are many and complex.
Firstly, lower revenues means that there is less cash circulating in the economy, and everyone knows that it is essential to get cash moving. It seems that it will take some time to get to the cash circulation levels of previous years.
Secondly, a reduction in costs could well involve a reduction in headcount, and there will be fewer jobs available on the market.
Thirdly, from experience it is likely that some of the cost savings will be made in relation to items such as training and development of the workforce. The problem with training is that it is an investment in human capital, and it is difficult to translate this into a balance sheet asset. If a company buys a machine for production, then everyone knows what it costs, what it does, the value it adds, but above all, you can enter the costs and quantify the advantages in the financial statements of the company. But how do you measure the benefits of training on the balance sheet? Everyone knows that the right training for the right employees produces better efficiency, but how do you measure it? The concern is that if training is reduced or eliminated, the effects will not be felt immediately, but over time employers will find that when business picks up they might not have as skilled a work force as they might like.
One has to sympathise with companies in this position. They want to survive, and have to find ways of reducing costs. But they cannot predict with any certainty the effect in the future of reducing training now.
All this of course assumes that business will survive. Well in general it will, but there will be casualties along the way. A frequently heard complaint of business is that their need for support in a cash flow crisis is not being met by the banking system and ultimately government. The banks have said they will listen sympathetically to any request for assistance, and the government has said that it is doing everything it can to make sure that it, the government, pays its invoices on time and makes VAT refunds quickly. Business hopes that both the banks and the government will deliver. Only time will tell.
Ray Breden is Director of Taxation Services at KPMG Romania.
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