by Mark J. O'Donnell
The future is rarely predictable, but 2024 looks more uncertain than normal, considering interest rates, potential negative economic growth, geopolitical risk to supply chains, workforce issues, and congressional self-interest. Whether you are a detailed planner or prefer to stay ready to react as needed, I cannot think of a better time to do basic financial strategic planning for your company. The purpose is to review, at a high level, the range of possible outcomes and, in each case, the economic decisions available. In this article we will focus on your use of cash.
By now, you should have a draft projection of your balance sheet, income statement, and cash flow statement for the year ending 12/31/2023, and if not use your year-to-date November statements. From there, prepare (or ask your accountant to prepare) three scenarios of projected income statements and related cash flow statements; those scenarios may be labeled ‘better, expected, and worse’ or maybe ‘the good, the bad, and the ugly.’ I use summary numbers for sales, cost of sales, operating expenses, etc., to avoid getting lost in the weeds. Details can be resolved later in the budgeting process.
Once satisfied with the income statement projections, focus on the cash flow report. As president, one of your critical roles is allocating resources, particularly cash.
Next, look at cash flow strategically. Based on your company’s financial position and where the company is in the current business cycle, how should you allocate available cash in the coming year?
Start with the first grouping on the cash flow report, cash flow from operations. Can cash flow be improved by changing your accounts receivable or inventory management processes? This question applies to any scenario; it is critical in a challenging economy.
Then, consider cash used for debt service. Right now, debt is a challenging and expensive area. If there is no other need for money, conservative debt reduction may be a good move, but don’t pay down so much that you end up cash poor. Of course, paying down your line of credit is almost always smart.
Finally, there are capital expenditures (CAPEX). Typically, there are two kinds of CAPEX: the need to replace existing equipment and the desire to make new investments to improve efficiency or capacity. As you have little choice about replacement, consider financing to conserve cash. The timing of investment in new property and equipment partially depends on where the company is in the business cycle. These investments are best early in the growth cycle, which may be months away.
If cash provided by operations, less debt service, and less CAPEX is a positive number, you may decide to distribute money to owners or retain it. This decision depends on many factors, including balance sheet strength, creditors and surety expectations, anticipated need for cash when the growth cycle returns, the company’s borrowing capacity, and the personal needs of the shareholder(s). However, it is generally thought retaining cash in a declining business cycle is a prudent decision.
From all of us to all of you, we hope you have a successful, happy and blessed 2024!
Mark O’Donnell, CPA, is Partner at Schmersahl Treloar & Co. He can be reached at 314.966.2727.