Getting Ready for Next Year's Great Recession

Don’t say you weren’t warned.

 

“We’re going into a recession, a really big one, bigger than 2008 – I’ll hang my hat on it,” John Taylor, founder of FX Concepts, the world’s largest currency hedge fund, told Bloomberg on July 20. “It’s descending upon us already. Next year’s going to look worse.”

 
Others are not as forceful, but they are nevertheless worried. “It would be fair to say there is some concerning information in circulation at the moment when it comes to the global economy,” says John Sutherland, executive manager, risk services, at leading trade credit insurer Atradius. “But it is far too early to be talking about a double dip [recession].”
 
Indeed, the markets cheered up on July 21 with the news that an agreement has been reached on a second rescue package for Greece, involving €109 billion (US$157 billion) in fresh funds.
 
Europe’s leaders also made an open-ended commitment to bail out any EU country, a declaration aimed at stopping the debt contagion from the EU periphery – Greece, Ireland and Portugal – to the much larger economies of Italy and Spain.
 
But the markets have become unsettled again as they digested the details of the accord -- and as US politicians failed to craft an agreement to raise the country's debt ceiling ahead of an August 2 deadline, risking a downgrading by the ratings agencies of America's prized triple-A credit rating.
 
Open Question
Is Taylor wrong? That’s an open question. Greece’s problems – and those of Europe as a whole – appear to be far more complicated and systemic to be easily solved by the mere injection of €109 billion in cash.
 
In a report published before the July 21 draft agreement, Royal Bank of Scotland economists estimated the price tag of solutions to “system wide issues” in Europe, not just Greece, at nearly €2 trillion. However, they warned, “the lack of political cohesion and rating threats to AAA countries are likely to prove to be a major impediment to actual execution.”
 
“There are new questions in Europe,” Atradius’s Sutherland told CFO Innovation. “At the same time, the US continues to struggle with its problems with regard to debt funding and political impasses.” Economic activity in the world’s largest economy has also failed to remain “at the consistent levels anticipated previously.”
 
In Asia, Japan is trying to recover from the recent devastating earthquake, tsunami and nuclear accident “without clear and strong leadership and policy,” he adds, “and China, which was a force in driving growth in 2008, 2009 and 2010, is revising expectations and preparing to battle inflation.”
 
“The key for me will be the next six months and how the reality of markets and trading zones plays out in conjunction with the sentiment,” Sutherland concludes.
 
“If both [reality and sentiment] head down, then we will see a double dip. If the circumstances remain as confusing as they are today, then the discussions will focus on winners and losers, the size and timing of a small dip and the longer road to sustainable recovery.”
 
What Should CFOs Do?
“Watch this space and be well prepared to react,” Sutherland counsels.
 
Fortunately, companies in Asia appear to be relatively cushioned against another global recession. In the latest CFO Innovation Asia Business Outlook Survey, released on July 20, 41% of the executives surveyed say their company is increasing cash on the balance sheet, while 37% will keep it at current levels. Only 21% will draw down cash in the next 12 months.
 
Resources are not being tied up in goods and raw materials, either. Just 20% of companies are increasing inventory, with 66% keeping it at current levels. Hiring is also decelerating, with 48% saying they expect the number of employees to rise – versus 54% three months ago and 60% in January.
 
Cost-cutting is also making a comeback. Reducing overhead costs is now a top-three strategic focus of 48% of respondents (versus only 33% in January); another 31% point to reducing direct costs as a top-three priority (25% three months ago).
 
And only 47% are renewing the company’s focus on sales, marketing and distribution, compared with 61% three months ago.
 
But 62% of respondents say their company is still expanding to new consumer segments and/or geographical markets. The majority (51%) are also increasing capital spending (three months ago: 52%), while 45% are spending more on marketing and advertising (three months ago: 46%).
 
The strategy seems to be to continue spending on front-facing activities while cutting back on back-office operations. The challenge is to strike the right balance between risk and reward to yield the optimum results if indeed there is a double dip recession – or if there is not.
 
CFO Check-Up
It is also a good idea for the company to look back at what it did right and what it did wrong during the global financial crisis in 2008 and 2009, and make sure it will not repeat the same mistakes.
 
To further arm themselves, CFOs can revisit Managing in a Downturn: The CFO Survival Guide, prepared by PricewaterhouseCoopers. This manual, CFO Innovation wrote in 2009, “puts together comprehensive and cleverly organised action plans for CFOs to consider as they navigate the treacherous waters of the global recession.”
 
PwC “combs through the income statement and balance sheet and makes recommendations for each line item that it believes the CFO needs to pay special attention to,” we explained. “It also examines areas outside the financial statements that the CFO is increasingly being asked to be part of, such as managing risk and decision support.”
 
Here are some snippets from the CFO Innovation articles:
 
Profit before tax
Short-term opportunities (less than three months)
  • Undertake a high level cost-to-serve review across your key customer, channel and product combinations
  • Develop plan for prioritised removal or remediation of the most loss-making combinations
  • Benchmark underlying cost metrics against competitive peer group
  • Identify and track key operational cost drivers.
 
Medium-term opportunities (three to 12 months)
  • Refine profitability model to allow ongoing tracking of cost-to-serve
  • Ensure underlying cost base is flexed in line with activity levels to maintain margin levels
  • Implement targeted reduction initiatives against primary cost drivers
  • Ensure working capital implications of any operating model change are reflected in cost-to-serve, to maintain the focus on cash.
 
Long-term opportunities (more than 12 months)
  • Consider opportunities to switch to lower cost/outsourced model for non-core operational elements
  • Identify strategic target for cost base and implement programme approach to move to this model.
 
Managing risks, compliance and internal audit
Short-term opportunities (less than three months)
  • Identify new risks, e.g. fraud, on third party partners etc
  • Review risk management spend and internal audit plan
  • Review controls over cash and working capital management systems and process Ensure compliance with financial regulation and proper controls for financial practices.
 
Medium-term opportunities (three to 12 months)
  • Reassurance that internal audit and risk management are operating effectively
  • Conduct a current state assessment of Governance Risk and Compliance (GRC) capabilities and identify gaps
  • Reduce costs and improve performance of key processes
  • Revisit major contracts to determine real value for money.
 
Long-term opportunities (more than 12 months)
  • Training and support of in-house internal audit staff
  • Access to relevant benchmarks for processes and controls
  • Seek comfort that the right processes, controls, technology and people are in place
  • Improve governance around information reporting and implement the right controls around data.
 
Click here for Part One, Part Two and the Final Part of the three-series article.
 
Been There, Done That
Review key customer, channel and product combinations? Remove or remediate the loss-making combinations? Benchmark underlying cost metrics? Identify and track key operational cost drivers?
 
Many CFOs will say that these are activities that finance routinely undertakes. That is true enough, but perhaps the return of plenty in Asia in the past two years or so has allowed a measure of laxity to set in. As PwC’s Edmund Lee observed to CFO Innovation in 2009: “People tend to be easier on the purse strings when times are good.”
 
Whether or not a recession “bigger than 2008” really does descend upon us in 2012, every CFO should redouble his or her effort to ensure that the income statement, balance sheet, risk management and compliance systems are as ship-shape as possible – even as finance forges ahead with analytics, forecasting, stress testing and business partnering.
 
About the Author
Cesar Bacani is Editor-in-Chief of CFO Innovation.    
 

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