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Seven tips to help CFOs and treasurers fight inflation

The dreaded ‘i’ word, inflation, has hit wealthy countries, emerging markets and developing economies. In fact, according to a recent Pew Research Center analysis, inflation rates have doubled in 37 out of 44 advanced economies over the past two years, and the US inflation rate has almost quadrupled over the past two years, possibly explaining why Americans have rated inflation as the nation’s top problem.

In Deloitte’s North American CFO Signals™ survey for the second quarter of 2022, respondents cited inflation as one of their most worrisome external risks. The Association of Corporate Treasurers’ (ACT) recent Business of Treasury 2022 report highlighted inflation as the second highest external concern for treasurers.

Many business leaders, finance and treasury executives underprepared for inflation

What heightens the inflationary concerns is that many business leaders feel underprepared for growing geopolitical risks and inflation, according to a report published by the specialist insurer, Beazley.

“Inflation is a dominant threat with 55% of business leaders in the UK believing they lack the necessary resilience to deal with it, which rises to 65% in the United States,” said the report, titled Spotlight on Geopolitical Risks.

From a treasury perspective, the Business of Treasury survey corroborates the notion that treasurers were not prepared for this level of inflation, stating that “Many treasurers will never have worked in a high-inflation environment before, which explains why inflation is now the second highest external concern for treasurers, alongside geopolitical uncertainty.”

There are legions of executives, including board members, finance chiefs and treasurers, who have never lived through a significant inflationary spike or coped with persistently elevated inflation.

“Many of the current generation of chief financial officers have limited experience in managing inflation, following years of low cost increases in the US and elsewhere, making them seek past playbooks for strategies,” reported the Wall Street Journal in an article published in July 2021.

CFO Dive supported this impression as well in an article published last year, saying, “To many CFOs under 50, rapidly rising prices are a relic from their parents’ past, as quaint and unfamiliar as sideburns and bell bottoms. They may have only heard vague references about how double-digit inflation repeatedly savaged U.S. companies from 1974 until 1981.”

Seven steps to fight off inflation

The US Federal Reserve (Fed) Chair Jerome Powell delivered a stark warning Friday about the Fed’s determination to fight inflation with more sharp interest rate hikes. Higher interest rates mean higher borrowing costs for organizations and can lead to a reduction in profitability.

As finance and treasury executives grapple with inflationary pressures that are being compounded by geopolitical conflict, they can lean on data, predictive analytics, advanced technology tools, supply chain resilience, prudent risk management techniques, cost efficiency, strategic pricing, stockpiling inventory, and other tools to blunt inflation’s edge and augment growth and strategic advantage in times of volatility and uncertainty.

To help treasurers and finance chiefs address the concerns sparked by inflationary pressures, here are seven important steps to combat soaring inflation:

Diversify supply chain for resilience, stockpile and improve visibility into all tiers

It is said that supply chain issues drive inflation, so it is important to strengthen relationships with current suppliers and to build up resiliency.

Diversifying sourcing and logistics routes, weaning off dependency from one supplier or one region, keeping more critical materials on hand, and identifying alternative domestic suppliers all help companies to reduce or eliminate delays and bottlenecks, to increase bargaining power and supply chain resilience, and to respond to surging inflation. In addition, strategic stockpiling of goods or raw materials that are sensitive to inflation will help ease the effects of rising prices.

It is also recommended that organizations have complete visibility into current inventory and all tiers of the supply chain. This allows them to determine the right amount of stock to keep on hand to meet demand without spending excessive money on storage. It also helps with evaluating potential multi-tier risk exposure.

Furthermore, mapping the sub-tiered suppliers and reviewing business continuity plans helps with the arrangement of increased stock where required and creates resilience in the supply chain.

Get strategic about pricing to navigate inflation

Inflation increases the cost of doing business. Price adjustments due to inflation may be necessary to sustain margins in a period of rising costs. However, simply raising prices to combat inflation can fray customer relationships, reduce sales and hurt margins.

It is important to bear in mind that inflation should not be used as an alibi to boost profits, but as a pertinent reason to offset higher costs and in consonance with a company’s long-term strategy.

An effective inflationary pricing strategy leverages analysis and understanding of cash flow, upstream (costs before production) and downstream (costs after production) costs, channels, competitor pricing, industry or sector reaction to inflation, customer behaviour and price sensitivity, and products and their profitability to drive targeted price increases. Such a strategy is anchored in value, a company’s long-term strategic objectives, and a comprehension of demand and market structure.

It helps to consider the organization’s stakeholders when communicating a price increase, particularly to customers. While communicating price increases to customers, convey to them your efforts to avoid a price increase and the continued value that your products offer. Remember, if you don’t disseminate the value that sets you apart from competition, you run the risk of losing profitable customers who don’t see enough value in your product or service to justify paying more.

To mitigate the impact of a price increase, companies can adjust product features, and even offer instalments, product bundling and unbundling. Done the right way, a price increase can strengthen customer relationships and overall margins.

Leverage scenario analysis for forecasting and planning.

2022 may be the year of uncertainty where treasury and finance professionals’ stress levels spiked over surging inflation. However, it also presents the opportunity to identify the factors or drivers that are most sensitive to inflationary pressures and then run those indicators through scenario analysis (various scenarios) to assess financial implications that can arise from a range of possible outcomes for more accurate forecasts and risk mitigation.

Running “what-if” scenarios to test various potential impacts of inflation – e.g., price doubling for certain raw materials, hiking interest rate by 0.75%, payroll increases for key positions by 10%, supply chain snarls causing 20% or greater delayed sales, oil prices jumping another 15% next quarter – allows you to understand what each scenario could mean for cash flows, helping you respond to inflation.

Hedge currencies and commodities

Hedging doesn’t just affect energy prices. It also hits currencies and other commodities.

Finance chiefs and treasurers now have more tools at their disposal to limit foreign currency or commodity price swings. For example, they can actively build foreign exchange hedge positions via forwards and options contracts (derivative contract) or offset higher material costs by negotiating directly with suppliers – e.g., buy a significant portion or all of your raw materials from suppliers early and lock in price before the costs soar.

Derivative instruments like knock-ins and knock-outs can also be used to protect against changes in currency and commodity market prices.

While hedging is an effective tool that provides protection against downside risk in times of uncertainty and inflationary environments, treasurers and CFOs must ensure that the organization’s hedging policy is compliant with regulations and confirm that it meets its primary objective – “It is the volatility in asset classes that you are trying to hedge or protect against; not necessarily trying to buy or sell at the best price,” cautions Craig Jeffery, managing partner at Strategic Treasurer, a leading treasury consulting firm.*

Review capital structure, refinance debt, and invest in gold

It is a good idea to understand and review your capital structure, comprising a mix of equity and preferred shares, bank loans, convertible debt, short-term credit and supplier credit, particularly those aspects impacted by interest rate hikes.

Take steps to increase cash flow, improve earnings visibility and cut borrowings. Refinance debt to maintain enough cushion and offset the impact of declining liquidity. In addition, develop alternative sources such as private debt and equity to enhance competitive strength and dynamics. If your company is awash in cash, put it to use to make strategic acquisitions.

When it comes to investments, none is a perfect inflation hedge. However, it is advisable to diversify your organization’s investments and reduce risk by moving a portion of your company’s investment portfolio into a traditionally safe-haven asset and inflation buffer such as gold.

A precious metal like gold is expected to thrive in an inflationary environment. In a recent article titled Gold and inflation: Why Should Traders Prepare for Inflageddon?, Capital.com examined the historical relationship between gold and inflation to determine whether gold was truly an inflation hedge.

Research by Capital.com's team of data analysts found that gold's annual returns have been remarkable when inflation rates in the United States exceeded the 10% mark, as per the chart below.

 

 

“This historical evidence demonstrates that gold has not been a reliable inflation hedge at any level of inflation; rather, it has been an asset to be held when inflation crossed a red line (above 10%), triggering fear of an out-of-control price spiral in the economy,” explains Capital.com’s analysis.

Make prudent cost cuts

A Bain & Company study that analysed 5,700 global companies found that “those that cut costs to improve productivity the most during previous inflationary periods achieved higher total shareholder returns (TSR) —27% was the median—than companies that took less action.” Bain determined productivity by measuring EBITDA and revenue growth.

Cutting expenses efficiently is vital for finance and treasury professionals to deal with inflation. In their book Cut Costs and Grow Stronger: A Strategic Approach to What to Cut and What to Keep, authors Shumeet Banerji, Paul Leinwand and Cesare Mainardi highlighted the importance of reducing costs without risking performance through a concept called “capabilities-driven cost reduction.”

The book explains that, “For most companies, cost cutting in a down economy means across-the-board slashing that ‘spreads the pain’ of budget reductions across many departments. While that may sound like the best approach for getting critical results fast and for limiting political infighting, it is a mistake—one that will leave your company weaker, not just smaller. Instead, companies that need to reduce costs should treat the challenge as an opportunity to identify and reinforce their key capabilities, while divesting from those activities that do not truly reflect the business's strengths or long-term goals. This more strategic approach will make your company more resilient as tough times continue and more robust as recovery begins.”

To adopt the capabilities-driven cost reduction framework, finance and treasury executives should first identify and clearly articulate their company's key capabilities – not just core competencies or skill sets, but those very few and concentrated strengths that, in combination, define how their organization competes. The book defines these as “the interconnected people, knowledge, systems, tools, and processes that establish a company’s right to win in a given industry or business.” You can then use this information to sort through business activities and expenses to ensure your spending is aligned to nurture these capabilities and create your company's unique blueprint for effective and efficient cost reduction.

Investing in emerging technologies, automating repetitive and manual tasks (including invoice processing), removing or reducing discounts and promotions, adjusting product design or specifications, rethinking packaging, renegotiating contracts (including transportation and logistics contracts) with vendors, slowing down hiring, focusing on high-margin and in-demand core products, and considering or pursuing vertical integration are some of the other effective cost-cutting measures that CFOs and treasurers can use as a catalyst for growth.

Buy when the purchase price is attractive

As a treasurer or a CFO, you can look to buy goods or raw materials when the price is low or before it goes up. Such buying may only cover a portion of the supply your organization needs, but by timing these decisions thoughtfully, you can take advantage of pricing opportunities. This can limit the exposure to inflation.

It is a well-known fact that inflation erodes purchasing power and makes today’s money less valuable tomorrow, so you should consider buying those raw materials or goods that you anticipate needing in the future at today’s prices.

Conclusion

Analysing receivables and payables, divesting underperforming assets, and scheduling thorough and regular reviews of the company’s balance sheet are also recommended strategies to free up cash and help your business respond more effectively to inflation.

As a CFO or treasurer, you and your corporation may not be able to fully escape the effects of soaring inflation. However, implementing the seven strategic options above will help take some of the bite out of inflation, unlock efficiencies and increase productivity.

 

⃰⃰ Disclosure: Strategic Treasurer owns CTMfile.

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