Fractional CFOs help business prepare for a downturn in many ways, ensuring they come out strong on the other side.
Fractional CFOs help business prepare for a downturn in many ways, ensuring they come out strong on the other side.
During the COVID pandemic, more than 700,000 business shuttered their doors in the second quarter of 2020, costing the American public around 3 million jobs. And this is not to mention the other 17 million jobs lost that quarter but weren’t due to a business closing down.
Although many businesses reopened in the third quarter, many weren’t so lucky.
So, what made it possible for some businesses to weather the storm while others were forced to close up shop?
A big part of the answer is preparation, both operational and financial.
To that end, if you don’t have a financial executive helping your company for when the next recession hits our shores, then perhaps it is time for you to consider bringing on a fractional CFO.
A fractional CFO, now sometimes called a virtual CFO, is a Chief Financial Officer who supports a company on a part-time basis. Depending on the circumstance, a fractional CFO can work remotely, in-office, or in a hybrid arrangement. A Fractional CFO usually works between 2-15 hours a week, but the work schedule is flexible, subject to the company's needs. When companies need full-time CFO support for a period of time, they typically call on an Interim CFO.
Fractional CFOs offer plenty of the benefits you get from a seasoned finance professional while only costing a fraction of the price. After all, the monthly cost of a good fractional CFO averages around $8,000 per month while you would have to pay around $33,000 per month for a full-time CFO.
Moreover, fractional CFOs have worked with several companies, so their breadth of experience makes them valuable contributors to your team. More importantly, they have seen companies at their best and worst times, so they know how to play offense when things are well and stand on defense when needed.
The effects of a recession are not uniform across the board. While several businesses might struggle as a result of the slowing down of demand, other businesses might not feel the adverse effects as much.
For instance, businesses that compete on cost tend to do well when there is a liquidity crunch in the economy. Also, businesses that serve people in financial distress, such as pawn shops, tend to coast through recessions unscathed.
However, other businesses, especially those selling non-essential items or those with elastic demand, need to prepare for recessions. And part of that preparation includes bringing the right team on board, including an experienced fractional CFO.
As Beatty D’Alessandro, instructor and mentor to Georgia State University’s graduate finance program, puts it: When you bring in a fractional CFO, part of their job is to always prepare for the worst-case scenario. They must ask themselves, “What could happen to the economy tomorrow that would represent a large enough shock to destabilize your company financially?” Once they’ve answered that question, they’ll be able to identify the edge cases that pose the biggest threat to you and report on them regularly.
To keep an eye out for any early warning signs, a good fractional CFO will build dashboards and sensing mechanisms to provide them with real-time insights. And at the first sign that the business is decelerating, the CFO can jump into action.
However, the fractional CFO also needs to identify your company’s specific risks. For instance, regarding your loans, the CFO will take your loan documents and deconstruct them into three to five key covenant items that could be the biggest problems in the event of a recession. Then, these covenant items will be incorporated into the dashboard your CFO is constructing. As a result, they will be able to monitor how close your company comes, if ever, to breaking one of those covenants.
Unfortunately, an economic recession counts as a shock that could financially destabilize your company. However, before the recession is in full swing, there are always key indicators that pop up, sort of like alarm bells going off.
Now, the problem here is that for most people, unfounded optimism tends to win over clear-headed rationality. Many will see the warning signs but assume that this is a temporary market perturbation and that things will return to normal quickly. Or, worse, they won’t believe the numbers and just assume something is wrong with the data.
But that is not how a fractional CFO thinks.
Instead, an experienced fractional CFO has learned through years on the job to trust the data, especially if it tells them something they don’t want to hear. They know that it is much better to gently hit the brakes rather than throttling the entire company with an abrupt halt, which can be traumatic, to say the least.
So, if your company misses some of its targets, or some of the projections are far off because a few large orders fell through, your fractional CFO will analyze the reasons and try to get to the bottom of it. They won’t wait till your company finds itself in the middle of a fire drill, trying to fight for its survival.
So, your fractional CFO has spotted a few signs indicating that a recession is on the horizon or, at least, the market is starting to slow down. What happens now?
For starters, the name of the game is making small incremental changes as opposed to large aggressive moves. For instance, instead of automatically looking towards making budget cuts and reducing your company’s workforce, the fractional CFO will start by slowing the overall velocity of hiring for a period. And if the fractional executive wants to be more conservative, they can close all open hires for the next month or two.
Usually, most battle-tested CFOs will have a playbook of sorts, detailing what to do should their company ever go through a slump. And a proactive CFO will start implementing bits and pieces of their playbook the instant the data and trends indicate rough times ahead.
As Beatty D’Alessandro says:
“I think most people would view a downturn to some degree. Oh, it's just a month. I don't have to do anything. It's going to get better. You know, there's something wrong in the numbers. A big order didn't come in, whatever it is. Then you have two months in a row and you still haven't done anything.
But, as a CFO, you come to it with a realistic sense versus an optimistic sense that these trends mean something. You miss a month, you miss two months. And now it's your job as an executive, particularly as a financial executive, to do something, right? Don't just stand back and watch it go down and not put into practice some sort of playbook. Do something about it, right?”
So, to recap, before the recession, a fractional CFO can put in place monitoring systems to keep a watchful eye. When the signs start showing up, the CFO must be vigilant and proactive, yet they must also work in small increments so as not to shock the entire organization.
But once the recession hits its stride, the fractional CFO plays a much more integral role. They manage your company’s working cash flow and minimize expenses, ensuring you have the liquidity needed to survive. They also work with your other executives to help them optimize their departments.
Over and above, even though a recession can be a difficult time for many, it can also be a great time to capitalize on rare opportunities, and a fractional CFO should pounce on them when they present themselves.
The idea is that until the turbulent waters of the economy clear up, your CFO wants you to maintain as much cash reserves as possible. After all, without enough cash on hand, companies might not be able to pay their employees on time.
To that end, the first thing your fractional CFO will do is negotiate with your suppliers, trying to get more lenient payment terms from them. If they can convince your suppliers to postpone collections for two weeks, they’ll push for that. If the CFO can restructure your company’s payment schedule, extending your runway at the cost of higher interest rates, they will push for that.
The second thing your fractional executive will do is review your company’s open purchase orders to buy assets or inventory for the business. The CFO will then discern which ones are necessary, which ones can be reduced, and which ones can be canceled altogether.
Remember, during a recession, your company won’t need to stock as much inventory as it normally would. Moreover, a lot of the capital expenditure you make during a recession can be reduced. For instance, if you are buying a fleet of 10 trucks, you can wait a few months for demand to dry up and then buy them for 75 cents on the dollar.
All that being said, one of the last levers you want your CFO to use is to pressure your clients to pay faster. While this pressure might provide you with working cash flow today, it will cost you some sales in the future when things get back to normal.
Now, what should your fractional CFO do in the case of an extreme economic shock? For instance, imagine we were back in 2008, and you just woke up to hear the news that Lehman Brothers went out of business. Or, think back to 2020, less than 4 years ago, and the president just got on TV to tell the nation that we are shutting down the economy for two weeks.
How can your business survive such a situation?
For starters, your fractional CFO will tap into your lines of credit. If you have any credit with any bank, your CFO will advise you to pull as much cash as you can out of those financial institutions. That way, even if the banks go broke tomorrow, you still have the cash you need on hand.
And it is worth bearing in mind that your banks don’t need to go broke for you to lose access to your lines of credit. Suppose a bank gets visited by regulators during a recession. In that case, the bank may very well refuse to fund any of their credit lines until the smoke clears, making their financial crisis become your financial crisis.
You have to remember that almost every department at a company is incentivized to maximize output. Managers of a factory want to manufacture as many units as possible, sales leaders want to sell as much as possible, and HR heads wish to fill all the vacant positions in the company.
But a fractional CFO is incentivized to maximize the return of your company, which sometimes means being prudent and acting as the voice of caution.
So, the CFO will sit with each department leader and find ways to cut costs without doing any permanent damage to the company. At the end of the day, maintaining the company’s working cash flow is a concerted effort requiring everyone to pitch in. What’s the point of saving money by closing open hires if the manufacturing department overproduces and burns that runway?
So far, we have discussed how a fractional CFO needs to help your company play proper defense. But during a recession, is there any room for a bit of offense?
The answer is yes.
When an economy goes through a recession, there are a few things that happen. First off, asset prices depreciate because demand has plummeted. Also, to stimulate the economy, the government will lower interest rates, making it cheaper to borrow money.
With that in mind, your fractional CFO might encourage you to purchase distressed companies. After all, as the Oracle of Omaha, Warren Buffet, says, “Be fearful when others are greedy, and be greedy when others are fearful.”
The other example of being opportunistic is trying to refinance your company’s loans. For instance, between 2020 and 2022, interest rates were at an all-time low. So, your fractional CFO should be working as hard as they can to get your company cheap money.
However, the real problem that your fractional executive might face is that at these meager rates, the banks might refuse to give out any loans. They might feel it prudent to withhold their capital till the waters settle down.
While it’s nice to think of the best-case scenario, where your company has enough liquidity to benefit from the depressed asset prices, the worst-case scenario involves your company being so strapped for cash that you struggle to make the bank payments on your business loans.
So, what can your fractional CFO do in this case?
They will likely head over to the bank and negotiate forbearance. However, the caveat is that the banks will probably charge your company a substantial penalty fee. More importantly, they will mark your company as a high-risk entity and a problem borrower, and the credit score of your business will drop. Furthermore, if you were to take out another loan again after the recession has passed, the bank would either charge you a high interest rate or would reject your loan application altogether.
This is why although negotiating forbearance might be necessary in some cases, you want to leave it as a plan of last resort.
Beatty D’Alessandro summarizes it best:
“You'd go to the bank and say, I can't pay this month. I want an extra 30 days, an extra 60 days, and it's entirely possible, particularly during COVID, that they would say, “That's fine.”
But that would not be a free trip. That would be an expensive trip. You would be paying some sort of penalty in addition to the interest when you paid it, and the next time you went to borrow, you would show, as a company that had enough problems that they couldn't manage their debt in an orderly fashion, and that would put you in a higher interest rate bracket, a lower credit score, lower credit rating or bond rating score, and that would be your last phone call after you've done everything else.”
Once the recession has passed, the fractional CFO becomes the voice of history, embodying the lessons that should be learned from the ordeal.
A prime example is how the 2020 economic recession showed us how frail our global supply chains can be.
Accordingly, a good fractional CFO should gently remind the CEO of the difficulties they faced when the world went on lockdown. The CFO should then recommend that the company look for raw material suppliers closer to home.
This sort of risk mitigation is baked into your fractional CFO’s job description. They need to think about things such as how would a war in Taiwan affect your business’s supply chains, and they use the lessons learned from recessions as valuable guides.
When choosing your next fractional CFO, there are a few things to consider regardless of whether you think there is another recession right around the corner or you just want a financial expert to help prepare your company for a worst-case scenario.
The first thing you should ask your potential fractional CFO is, “What were you doing during the last recession? What was your title, and what were your duties?”
Ideally, you want people who were in leadership positions and led the finance function during a recession before. Accordingly, this guarantees that they have firsthand experience with the tumultuousness of a recession, and they might have even developed their own playbook to deal with those tough times.
And if they weren’t leading the office of the CFO during the last recession, then you want them to have at least had a front-row seat and watched a seasoned CFO traverse the recession like a pro. This means that the candidate might have been a controller or treasurer working with the CFO at the time.
The last thing you want is someone who will still have to invent the wheel. Recessions are unpredictable animals by their very nature, and regardless of how prepared your company may be, a crisis may still strike at any moment, jeopardizing your life’s work.
As a result, you need a battle-tested CFO to help ferry you through these rough times. You want someone who has negotiated forbearance and has fought to get their client better rates.
In addition to the experience, you should look for a fractional CFO who is a good communicator and meshes well with your style as a CEO. You want someone you can trust and to whom you can delegate some of the most important tasks you need tackled while you take care of the rest.
As you can see, a fractional CFO can help before a recession rears its head. They can make sure your company is battle-ready. And the minute they see signs that things are slowing down, they can start pushing the right levers to incrementally lower spending and increase savings. However, once the recession is at its peak, your fractional CFO will do everything possible to ensure your company’s survival while causing minimal permanent damage. Finally, after the recession has passed, it will be their job to help you perform a post-mortem and see what lessons there are to be learned.
All that being said, if you are considering hiring a fractional CFO or just want to explore how you can make your business better prepared for the next time the economy slows down, please do not hesitate to reach out. We are always happy to help and offer you a free consultation.