The Current Economic Environment is New Territory for Many CFOs

Sergei-1 (1)
Sergei Galeano, CPA

For many active CFOs in the corporate world today, the current and impending economic circumstances are a whole new territory for them to deal with. Inflation and borrowing rates continue to increase and will create issues that many current CFOs have not had to resolve during their tenures.

Since the 2008 recession and into 2021, inflation (CPI) in the US had averaged 1.7% annually, briefly peaking at 3.0% in 2011. For the prior 13-year period, 1995 – 2007, the average was 2.65%, and from post Jimmy Carter to 1994, 3.6%. 2021 ended with a 7.0% increase, and unfortunately 2022 is off to a worse start since the early 1980s, nearing 9% through the first half of the year.

Economists are debating and forecasting a peak in inflation later this year, but much of the damage has been done and elevated rates will continue for a while.

The same trend holds true for the Prime Rate, a rate upon which much of the corporate financing is based. After almost a two-year run at 3.25%, the prime rate is now 4.75% and climbing. Since early 2008, the prime rate has been generally under 4.0%, with a brief stint in 2018 – 2019 in the 4% – 5.25% range.

Many of today’s CFOs have not had to deal with these higher costs and borrowing rates. It will require a shift in their strategies, and they will be the key member of the executive team to be focused on these areas.

Inflation Impact

CFOs will have to sharpen their forecasting and analysis skills, as well as their pencils, as the impact of inflation on all their costs is magnified. The importance of cash flow is heightened during inflationary times, so the attention to receivables collection and inventory management must also be heightened. Constant updates to the cash flow forecast and monitoring key financial metrics will take on greater importance. The CFO will also need to include an evaluation of all critical vendor relationships to ensure they are getting the best pricing, understanding anticipated pricing changes and any potential supply issues, and evaluating supply and service alternatives. Companies always want to have options should a vendor fail to perform, becomes difficult to work with or just too expensive. This increases the importance for alternative sources for raw materials, service providers and product delivery needs.

CFOs will also need to consider what impact their rising costs should have on the price of their products and services. They will have to understand the market, their competition and their specific customers. Proper planning and forecasting can give them a better idea of the impact of their decisions. They won’t want to alienate the customer with higher prices, but they want to ensure that they maintain their profitability.

Inflation doesn’t only affect goods and services. We are all aware of the worker shortage and the increased pressure on wages that this shortage and rising costs have. The CFO will need to advocate thinking outside the box in this respect. They can’t just throw money at it, although they will have to spend more. The CFO must work with the executive team to find ways to make their company more attractive aside from just the wages. Work/Life balance initiatives and ensuring they have a non-hostile; supportive working environment are a few ways to help. Also, they can work with their HR team to develop new ways to find the workers they need. The more applicants/prospects they have, the more they can control their costs by having the right people in the right places and minimizing the effect of turnover.

Interest Rates

Many CFOs have not had to deal with higher financing rates in general or regularly rising interest rates. With anticipated ongoing increases of the borrowing rate by the Federal Reserve, largely prompted by an attempt to quell inflation, this will not be the case going forward. CFOs will have to work a little harder to get the lowest rates they can. This is often achieved with solid and consistent reporting, supportable forecasting and an ability to tell the company’s story to prospective lenders.

This environment may change a company’s investment plans and marketing initiatives. More emphasis on an investment’s ROI and Net Present Value will be needed as the number of investments pursued may now be more limited.

CFOs will need to keep an eye on financial performance covenants as well, as rising interest rates and lower profits may now impact those covenants in the future. Again, proper forecasting can help identify any potential issues and allow the company to get ahead of any issues with their lenders.

And along with the cash flow issues pertaining to receivables and inventory noted above, the cost of financing those assets can increase significantly with rising rates, placing additional pressure on controlling the investment in working capital.

Ultimately, the CFO’s role is to provide information to the management team that has a sound basis in financial modeling for different scenarios so that informed decisions can be made. The CFO bears the main responsibility for communicating the impact rising inflation and debt costs can have on the company’s performance. They are an advisor for the rest of the organization.

The Current Economic Environment is New Territory for Many CFOs 1
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