Deleveraging Done Right with Cash Forecasting | Manufacturing Industry Edition


Use this e-book to understand the pros and cons of leverage and how the treasury department can align with the company’s goal during a volatile economic climate.

Contents

Chapter 01

If Assets Depreciate, Get Rid of Your Debt

Chapter 02

Deleveraging During COVID-19
The Last Straw for Manufacturing Industry

Chapter 03

Role of AI-Enabled Cash Forecasting for Orderly Deleveraging

Chapter 04

Summary
Chapter 01

If Assets Depreciate, Get Rid of Your Debt


 Why companies go for borrowing

Deleveraging essentially comes down to reducing debt. It can be accomplished either by generating more cash or selling off assets such as real estate, stocks, bonds, divisions, subsidiaries, etc. The objective of deleveraging is—most often—to reduce risk when the deleveraging is voluntary.

Source: thebalance.com, “What Does Deleveraging Mean?

Why Companies Go for Borrowing (or Leverage)

Let’s say you buy an asset, a vintage car, worth $1,00,000. Over time, the value of the asset (the car) appreciates. Here are two scenarios where:
1. You buy the car entirely using equity
2. You split the cost where you pay half using equity and half by borrowing (debt)

Why deleveraging makes sense during recession

By running the numbers, after one year, the return value of buying with the help of debt (leverage) is higher (112%) than buying entirely with equity (110%). Hence, it makes perfect sense to go for leveraging when assets are appreciating.

Why Deleveraging Makes Sense During Recession

However, the situation changes during a recession when the value of non-essential items (such as vintage cars) depreciates. Similar to the above, here are two scenarios:
3. You buy the car entirely using the equity
4. You split the cost 50-50 between equity and loan

Why Deleveraging Makes Sense During Recession

In this case, the return value of buying entirely from equity is much higher (90%) than buying with the help of debt (72%).Hence during recession, if your assets are depreciating, it’s best to get rid of maximum debt.

Bottomline

During appreciation, leveraging makes sense.
During depreciation, deleveraging makes sense.

Chapter 02

Deleveraging During COVID-19
The Last Straw for Manufacturing Industry


COVID-19 has impacted certain industries more than others. Certain manufacturers are struggling under COVID-19. With the inability to sell products and collect receivables, they are likely to run into a cash crunch.

For sustaining their businesses, they have to consider difficult measures such as layoffs, furloughs, temporary/partial plant closures, selling receivables, and shutting off business lines.

Industries impacted the most by COVID-19

Disorderly Deleveraging Leads to:

  • Short-sighted approach in managing cash
  • Difficulty in knowing if cost-cutting measures are effective without forecasts
  • Permanent negative impact on businesses
  • Job loss for employees
  • Lack of objectivity while making decisions
Chapter 03

Role of AI-Enabled Cash Forecasting for Orderly Deleveraging


1. Be a Strategic Ally to the Business by Having Big Picture Visibility on Cash

Utilize 9 Months Cash Forecasts into the Future

Treasury can continually increase their profile by providing proactive guidance to the business. With accurate long term cash forecasts, they are able to see the big picture view of cash and help the company take proactive measures to improve and mitigate any shortfall of cash.

Decrease Interest Expenses with Long-term Forecasts

With accurate long-term forecasts, Treasury has visibility on available cash that can be utilized to pay debt faster and responsibly while decreasing interest expenses.

2. Have Global Cash Visibility

By having global cash visibility, treasury can find opportunities for

  • repatriation (bringing back cash home)
  • paying down foreign currency-denominated debt.

3. Run Scenario Planning for Impacts of Cash Flow

Will it be a U-shaped recession or
L-shaped recession?

Run what-if scenarios to see the possible impacts of cash for a variety of scenarios and analyze how the recovery goes.

4. Estimate Available Cash with Continued Variance Analysis

It is important to understand the likely accuracy of forecast considering its past performance. Without doing variance analysis it is difficult to estimate if the forecasts are accurate or not and how far into the future they are accurate and to what degree.

Continued variance analysis helps determine the degree of confidence needed for long term forecasts. And based on that confidence level as well as possible variance, treasury teams can make the right decision as to how much cash is available to leverage.

Chapter 04

Summary


Quite a number of companies had 2020 plans prior to COVID-19 that stressed on the importance of deleveraging. COVID-19 has simply made the need for it that much greater. For businesses that are struggling with decreasing assets, the weight of debt can become burdensome. The first sign of a company being in trouble is not being able to make their debt payments.

The solution is to have a system plan out your baseline and put in a variety of different assumptions on what could happen if the recession ends i) in a few months, ii) by fall, or iii) in two years.

What’s the impact on cash?
FP&A can estimate what the overall company’s impact is from a P&L perspective. But only Treasury is looking at cash and can determine the impact. And that is what a true bottom-up cash forecast can do.

Managing working capital during uncertain times requires Treasury leaders to have a clear sense of the short-term cash position and be able to forecast future cash with a high level of accuracy & confidence. Having a best-of-breed cash forecasting solution is the need of the hour.“
Shayne Higdon
General Manager, HighRadius

Chapter 01

If Assets Depreciate, Get Rid of Your Debt


 Why companies go for borrowing

Deleveraging essentially comes down to reducing debt. It can be accomplished either by generating more cash or selling off assets such as real estate, stocks, bonds, divisions, subsidiaries, etc. The objective of deleveraging is—most often—to reduce risk when the deleveraging is voluntary.

Source: thebalance.com, “What Does Deleveraging Mean?

Why Companies Go for Borrowing (or Leverage)

Let’s say you buy an asset, a vintage car, worth $1,00,000. Over time, the value of the asset (the car) appreciates. Here are two scenarios where:
1. You buy the car entirely using equity
2. You split the cost where you pay half using equity and half by borrowing (debt)

Why deleveraging makes sense during recession

By running the numbers, after one year, the return value of buying with the help of debt (leverage) is higher (112%) than buying entirely with equity (110%). Hence, it makes perfect sense to go for leveraging when assets are appreciating.

Why Deleveraging Makes Sense During Recession

However, the situation changes during a recession when the value of non-essential items (such as vintage cars) depreciates. Similar to the above, here are two scenarios:
3. You buy the car entirely using the equity
4. You split the cost 50-50 between equity and loan

Why Deleveraging Makes Sense During Recession

In this case, the return value of buying entirely from equity is much higher (90%) than buying with the help of debt (72%).Hence during recession, if your assets are depreciating, it’s best to get rid of maximum debt.

Bottomline

During appreciation, leveraging makes sense.
During depreciation, deleveraging makes sense.

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The HighRadius™ Treasury Management Applications consist of AI-powered Cash Forecasting Cloud and Cash Management Cloud designed to support treasury teams from companies of all sizes and industries. Delivered as SaaS, our solutions seamlessly integrate with multiple systems including ERPs, TMS, accounting systems, and banks using sFTP or API. They help treasuries around the world achieve end-to-end automation in their forecasting and cash management processes to deliver accurate and insightful results with lesser manual effort.