Optimising the Balance Sheet for Resilience & Flexibility
By Shoaib Yaqub, Head, Financing Solutions & Advisory Team, Standard Chartered
Corporate business leaders have never faced more complex challenges in anticipating, understanding and responding to new business trends, and positioning their organisations accordingly. Increasingly, new technologies, industry players and societal trends are disrupting the way that competitive advantage is achieved, and what it means to be a global corporation when the concept and benefits of globalisation are in question.
Treasurers and finance chiefs can neither predict nor determine the future environment in which the company operates, and the shift in strategy that might be required. What they can do, however, is to equip their organisations to be flexible and responsive to change, and enable them to pursue growth opportunities. At the same time, they need to ensure that the business is resilient in the face of changing market and geopolitical conditions.
An overwhelming majority of CFOs consider capital structure to be a key priority (90% according to a recent survey conducted by PwC ) and are focused more than ever on finding ways to optimise the balance sheet to combine financial resilience and flexibility whilst minimising costs.
The global challenge
Every generation makes the claim that it is going through a more challenging period than the one that preceded it, but there is a strong argument that we are in a period of unprecedented complexity. On one hand, global economic uncertainty and the frequency of ‘black swan’ events mean that while forecasting has always been an imprecise art, it is more difficult than ever not only to predict events and trends, but also the way that markets and institutions will respond.
Take for instance the recent US tax changes. These changes may materially change the optimal balance of equity and debt suitable for a corporate paying US tax, reducing the attractiveness of debt as the tax shield benefits evaporate. However, a knee-jerk reaction to that may cause long-term value destruction and needs to be more carefully evaluated with other variables that are in play as well.
At a micro level too, treasurers and CFOs face a unique set of circumstances. With many corporations deleveraging significantly over the past few years, they now have large amounts of surplus cash on their balance sheets. Business leaders therefore need to determine how they will use this cash, or return it to shareholders, which may be a less attractive option if future competitiveness is hampered as a result.
While neither macro- nor microeconomic challenges are new, these are combined with a rapid acceleration of innovation and disruption in industries as diverse as automotive to advertising. With new technologies and market players increasing competition and challenging existing business models, treasurers and CFOs need to support their organisations by being financially flexible and leveraging opportunities for M&A, organic growth and investment in new solutions and technologies.
A structured approach to capital structure success
Although many treasury and finance functions have significant corporate finance skills, issues such as financial policy, credit rating, debt levels and liquidity buffer are top of mind for many treasurers and CFOs. In particular, many are looking to make sure their balance sheets are ‘bullet proof’ in the face of unknown challenges and opportunities ahead, and the need for both agility and competitive cost of capital. This involves evaluating, optimising and benchmarking their balance sheet strategies, including:
1. What’s the outlook for my business?
This is a complex undertaking given the scale, speed and impact not simply of individual trends and innovations, but also the combination, that together are redefining industry boundaries, business models and the role that each organisation fulfils
The analysis should include detailed, informed assumptions around revenues, changes in working capital, acquisitions and disposals, share buybacks, dividend payments, applicable tax rates, interest income, cost of debt, and new debt issuance, amongst others.
This output is valuable in helping to develop a more detailed understanding of key factors such as liquidity outlook, projected return on investment in R&D and expansion into new territories, product and customer segments, and the potential impact of the economic, societal and regulatory environment in which it operates.
The value of this process should not be underestimated. According to the PwC survey referenced previously, 78% of CFOs say that they determine funding decisions on future capital needs based on internal forecasts, but as every treasurer will note, this is not a failsafe process, with 42% of treasurers emphasising that forecasting is a major challenge for their business. By adopting a more rigorous approach that combines a wide spectrum of quantitative data and qualitative insights, treasurers and CFOs can build a more comprehensive view of the company’s likely capital requirements to fulfil its strategic objectives, and challenge, test and potentially modify these expectations to reflect perceived stresses or opportunities.
2. How can I make my balance sheet bullet proof?
Having established the likely capital requirements, the next step is to dissect its various components and analyse opportunities to increase resilience and agility, whilst minimising overall costs. This is far more than an academic exercise given both the conditions in the capital markets and the importance of getting the right mix of debt and equity.
While some shareholders may encourage, or even oblige, management to increase dividends or shareholder pay-outs and, in the process, leverage the balance sheet with cheap debt, the capital structure still needs appropriate buffers. For example, a corporate pursuing a proactive investment strategy needs to retain access to funding as opposed to being fully leveraged. Evaluating the size of this buffer and effectively communicating it to shareholders is therefore as important as minimising the cost of capital.