The financial measures that CFOs are turning to as the downturn bites

With operating conditions getting tougher and a recession beckoning, CFOs are looking beyond the conventional indicators to demonstrate the fundamental strengths of their businesses to investors
Computer with chart measuring growth sitting on the table of a modern boardroom

Finance chiefs face a barrage of challenges as they head into the new year. Inflation is surging around the world, interest rates are being cranked up at a faster pace than expected and several developed economies are facing the prospect of a deep recession. The Office for Budget Responsibility has warned of the biggest decline in UK living standards in the UK for six decades. 

With the economic pressures mounting, most CFOs in this country consider expanding their businesses to be their main priority over the next two years, according to research by Gartner. Yet most are also braced for falling revenues and rising costs in the short to medium term, with 91% of UK finance chiefs polled by Deloitte in October expecting a decline in their firms’ operating margins over the next 12 months.

With this in mind, many are turning to financial indicators that can highlight the underlying health of their companies even if top-line growth is stalling.

There are three things that Edmund Reese, CFO at fintech business Broadridge, focuses on during downturns. The first is client retention, which might mean adjusting payment terms to help a debtor experiencing economic difficulties and ensure that it remains a going concern. 

The second factor is “capital strength”, which entails maintaining liquidity, particularly if the business believes that cash flow could become an issue in the longer term.

The third factor to focus on is an accounting ratio known as operating leverage, which concerns a company’s cost structure. If the revenues of a firm with a high operating leverage – that is, a large proportion of fixed outgoings relative to variable costs – increase, that tends to have a more beneficial effect on its profit margins. But, if revenue falls, that same high leverage can be problematic, because the firm is generally more limited in its ability to reduce its cost base.

“You need to scenario plan and identify the levers that you can pull at the right times,” Reese says. “If you’re just reacting to situations as they unfold, you’re likely to overreact or underreact. But, if you can do all of those things, you can win through the recovery.”

Pushing for productivity growth

Some organisations will track the same set of numbers regardless of the wider economic conditions, although some of these may demand closer attention.

“We’re going to be very focused on productivity to ensure that we’re managing our labour as carefully as we possibly can,” reveals Scott Bogard, CFO of Exacta Land Surveyors. “We still have many opportunities to improve productivity in our operations. We would expect our crews to be able to do more in any market, so we’re going to keep pushing on that.”

Every recession is different, so you must realise that what you did yesterday isn’t necessarily going to be the right thing and suffice today

Downturns often create opportunities for a more established company to increase its market share if they put smaller rivals out of business. It’s another metric that can show the basic strength of a business even if its revenues aren’t growing. 

“With strong liquidity, we’d expect to be able to take share in the market,” Bogard says. “We can really focus on winning new clients to make up for the fact that some of our existing ones might be doing a little less business for the foreseeable future.”

CFOs are coming under increasing pressure to provide regular guidance on performance, which can be a challenge when the economic conditions are so uncertain, notes Matt Benaron, co-founder and director of VantagePoint Consulting.

He says that the question “I know a lot of CFOs struggle to answer is: what will the forecast look like in 12 months if something big changes over that time? The finance chiefs who’ll fare better throughout this period will be those who have invested in tools that enable them to better predict outcomes and equip them to say: ‘If we were to pivot the business in this direction, the likely financial results would be as follows.’ That is what will differentiate CFOs who can be real enablers in a period of lower growth.”

Turning to non-traditional metrics

Reese believes it’s also important for CFOs to manage people’s expectations in the wider business with respect to the best way to handle a downturn. 

“Every recession is different, so you must realise that what you did yesterday isn’t necessarily going to be the right thing and suffice today,” he stresses.

That means it’s important to be adaptable – for instance, by abandoning guidance on certain metrics if the firm has had to change its plans because of an unforeseen change in the market.

Organisations may increasingly point to non-traditional metrics as signs of success, particularly those relating to matters of environmental, social and corporate governance (ESG). Many investors are paying closer attention to these aspects as well, Benaron observes.

As more and more institutional investors adopt ESG frameworks to assess risks and opportunities, “that will certainly create new metrics, all of which will drive share price and, potentially, profitability”, he says. “The potential challenge is that sustainability programmes often come with increased short-term costs as opposed to savings, so there will be a conflict between investment in sustainability initiatives versus investment in initiatives that drive short-term profitability.”

Technology also has the potential to open up other non-traditional metrics by enabling organisations to obtain information they may not have previously tracked, such as figures indicating the efficiency (or otherwise) of a supply chain.

“This is really about maximising and better harnessing the data that finance chiefs have access to,” Benaron says. “Our message to CFOs is to look at more granular data. This will enable you both to pick up on trends that can influence decision-making and gain insights that may help you understand performance in a way that traditional reporting tools don’t.”