These are unprecedented times for businesses. How to stay afloat in adverse circumstances is the thought troubling many entrepreneurs. Those who can weather this storm by minimizing losses will stand to gain in the long term.
There are many ways to reduce loss and stay in business till the situation improves. Here I am only looking at ways to improve your profits using financial statement forecasts and by using some financial ratios.
Definitions
Accounts Receivable Turnover Ratio(AR TO Ratio)
This ratio shows how efficient a company is at collecting its credit sales from customers. Some companies collect their receivables from customers in 90 days while other take up to 6 months to collect from customers.
Inventory Turnover Ratio
Inventory turnover is a ratio showing how many times a company has sold and replaced inventory during a given period
Accounts Payable Turnover Ratio(AP TO Ratio)
Accounts payable turnover shows how many times a company pays off its accounts payable during a period.
Asset Turnover Ratio
This ratio helps investors understand how effectively companies are using their assets to generate sales.
Scenario 1 No action Taken
1. 25% decrease in sales
2. PPE no change
3. Some Opex are variable and some are fixed
4. Financing cost remains the same
5. Income Tax rates remain the same
Workings:
1. AR,AP, Inventory decreased in the same ratio as sales
2. Loan is the same
3. COGS remain at 70% to sales
4. Some expenses are variable, and some are fixed
5. Interest is 10% of the Loan
6. Depreciation is the same as there is no change in PPE
Conclusion
Net profit has decreased by 100% even though sales has decreased only 25%. There is a break even situation here.
How do we improve this situation?
Scenario 1(a)
1. 25% decrease in sales
2. Sold off some PPE
3. Some Operating expenses are variable and some are fixed
4. Loan repaid to a large extent
5. Income Tax rates remain the same
Workings:
1. AR, AP, Inventory and Asset Ratios improved by close supervision.
2. Using the excess cash generated, we paid off a large portion of loan, resulting in a decrease in interest.
3. Reduced the fixed salary of the employees slightly
4. Some expenses are variable and some are fixed.
5. Interest is 10% of the Loan
6 Depreciation has reduced
7 We let go of some of the office spaces that were not required and re-negotiated the rates
8 We sold some of the PPE and used the cash to reduce the loan liability.
Conclusion
Net Profit has decreased by 22% whereas sales decreased by 25%. Will be able to survive till the situation improves.
Scenario 1(b)
1. 25% decrease in sales
2. Due to the market conditions, assets could not be sold
3. Facing difficulties in Accounts Receivables collections
4. Financing cost is the same
5. Income Tax rates remain the same
Workings:
1. AP and Inventory ratios improved by close supervision.
2. Using the excess cash generated, we paid off a large portion of loan, resulting in a decrease in interest.
3. Decreased Fixed salary slightly.
4. Some expenses are variable and some are fixed.
5. Interest is 10% of the Loan
6 Depreciation is the same as there is no change in PPE
7 We let go of some of the office spaces that were not required and re-negotiated the rates .
8 We re-negotiated with the raw material vendors and got a better rate
Conclusion
Net Profit has decreased by 30% whereas sales decreased by 25%. Able to survive and weather out the storm without letting go of any employees as there is still profit despite the tough situation.
Scenario 2 No Action
1. 50% decrease in sales
2. PPE no change
3. Some Opex are variable and some are fixed
4. Financing cost remains the same
5. Income Tax rates remain the same
Workings:
1. AP and Inventory ratios improved by close supervision.
2. Loan is the same
3. COGS is high due to the fixed salary
4. Some expenses are variable and some are fixed
5. Interest is 10% of the Loan
6 Depreciation is the same as there is no change in PPE
Conclusion
Net profit has decreased by 161% even though sales has decreased only 50%. May not be able to survive due to the huge losses.
How do we improve this situation?
Scenario 2(a)
1. 50% decrease in sales
2. Could not sell off assets
3. Some Opex are variable and some are fixed
4. Need to avail some of the new facilities offered by Government which will reduce the loan rate
5. Income Tax rates remain the same
Workings:
1. Improved the AP and Inventory ratios by close supervision.
2. Brought down the loan interest rates by availing government schemes
3. Reduced fixed and variable pay rates
4. Vacated many retails stores and retained only the crucial ones, renegotiated rentals and reduced the corporate office space.
5. Adopted online selling
6 Depreciation is the same as there is no change in PPE
7 We re-negotiated with the raw material vendors and got a better rate
Conclusion
We have made profit though sales is down by 50%. This ensures that we can weather the storm and survive till the situation improves, without letting go of any employees.
Scenario 2(b)
1. 50% decrease in sales
2. Could sell off some assets
3. Some Opex are variable and some are fixed
4. Income Tax rates remain the same
Workings:
1. Improved AR, AP and Inventory ratios by close supervision.
2. No change in Loan rate
3. Reduced fixed and variable pay rates
4. Vacated many retails stores and retained only the crucial ones, renegotiated rentals and reduced the corporate office space.
5. Adopted online selling
6 Depreciation has reduced
Conclusion
Profit is at almost the same levels though sales is down by 50%. This ensures that we can weather the storm and survive till the situation improves, without letting go of any employees.
Scenario 3
No Action taken
1. 75% decrease in sales
2. Same assets
3. Some Opex are variable and some are fixed
4. Income Tax rates remain the same
Conclusion
Bleak situation of heavy loss. May not survive the situation
Scenario 3(a)
- 75% decrease in sales
- Could sell off some assets
- Some Opex are variable and some are fixed
- Income Tax rates remain the same
- Availed Government schemes
Workings:
- Improved AR, AP and Inventory ratios by close supervision.
- Paid off loan
- Reduced fixed and variable pay rates.
- Aggressively reduced rental expenses by vacating most of the spaces
- Adopted online selling
- Depreciation has reduced
Conclusion
We have made profit though sales is down by 75%. The Company can survive.
From this article, you can understand that by constant supervision of ratios you can come out of this bleak situation. You need to have forecasting done based on the current outlook and identify the areas of improvement. The earlier the corrective measures are taken, the better chances for survival.
CAclubindia
