By Aaron DeSouza, Audit partner, and Matt Chambless, Audit manager
Microsoft is cutting jobs and Google shares are down. IPOs have all but dried up. Inevitably, the technology industry has begun to feel the effects of investor anxiety, decreased business and consumer spending in the U.S., and reduced funding for early-stage companies. Once thought to be insulated from the economic turmoil gripping the financial markets, the technology sector is being squeezed by slow growth, weak demand and reduced lending by banks. Admittedly, the industry tends to be better-positioned than other sectors of the economy, since many technology companies may have the cash to ride out a downturn, but that doesn’t mean the technology sector is not experiencing – in some cases acutely – the impact of the credit crunch.
What can technology companies do to manage the credit crunch? We advise taking proactive steps to prepare for the potentially challenging days ahead by instilling rigor and discipline throughout your business. What follows are some pragmatic tips to maximize success in the coming months.
1. Build and conserve cash.
In a slow economy, understanding and managing cash flow are paramount. Liquidity can become constrained very quickly and, unlike in the past, banks are no longer willing to step in and fill funding gaps. In fact, cash flow-based lending, which is common at technology companies, is even tighter than asset-based lending.
It is therefore important to focus on the components of working capital and the cash conversion cycle. Forecast near-term cash receipts and cash disbursements based on realistic financial projections and a sound starting point, and include an analysis of the impact of those assumptions on your borrowing base. Cash forecasting is crucial for technology companies, given the frequent disconnect between revenue and cash. Watch your deferred revenue balance and inventory backlog. Also, analyze variances and learn from them. If you don’t have this information, bring in outside help. You need to look beyond sales and expenses and focus on actual cash, not just EBITDA.
2. Be relentless on cost control.
Tough economic conditions require a razor-sharp focus on cost containment in general, and cost cutting where possible. Look hard at discretionary expenses and pick off the easy wins in areas such as travel, general expenses and entertainment — without compromising business strategy.
Institute policies that encourage and reward cost savings and cash conservation. Employ zero-based budgeting to review all costs in terms of their value to the business. What costs are essential to running the business? Reduce spending as much as possible, and hold managers accountable for all expenditures and cash outflows. Institute cost justification and baseline investment returns for new projects. Understand your fixed and variable costs and any outstanding liabilities not reflected on your balance sheet (e.g., operating leases, rents, performance contracts), and find opportunities for reducing costs. Keep selling, general and administrative (SG&A) expenses under tight control. Pay close attention to variable costs and reconsider capital expenditure decisions. For technology companies, this often includes costs related to developing software for internal or external use. Don’t overlook a major area of expense: people.
3. Evaluate customers and suppliers.
The recent challenges in credit markets, as well as a general economic downturn, have put increased pressure on the purchasing power and creditworthiness of customers. Re-evaluate credit terms with customers and negotiate the shortest reasonable terms. Carefully review and continuously monitor the creditworthiness of each customer – new and existing – before extending credit. This will ensure full payment in accordance with stated terms. Monitor customer accounts receivable aging and quickly address accounts that are past due. Request regular financial information from your largest customers to identify and evaluate risk.
4. Examine your product line.
Technology companies’ customers are re-evaluating their purchasing behaviors in light of the economic downturn. Now is the time to examine your own product line and tailor your offerings to customers’ core needs; bells and whistles may be dispensible. If your product can help customers increase efficiency and cut costs, the downturn may provide excellent opportunities to grow your customer base.
5. Get smarter on tax.
Tax, in various forms, is usually one of the biggest overhead costs in a business, and it is important to look carefully at how to manage that cost and the related impact on cash flow. Take appropriate advantage of opportunities to reduce your tax liabilities, such as fully utilizing available credits and deductions and making the smallest allowable estimated tax payment. If your company operates across multiple state and local jurisdictions, there are many opportunities to manage cash and reduce taxes in the sales-and-use and property tax arenas. In terms of corporate income taxes, businesses should take advantage of the available tax credits. For example, the credit for increasing research and development activities may offer significant annual tax savings for technology companies. In some cases, current-year credits may be carried back one year to generate a refund of taxes paid.
6. Be cautious about capital investment plans.
Investing in new assets in a downturn can bleed you of cash when you need it most. Then again, uncertain economic times also can present great opportunities for companies that are able to position themselves effectively. So while you should be very cautious about capital investments, there may be promising opportunities, particularly if your products increase efficiency and decrease costs to customers. Carefully consider capital investment plans, and question the proposed value and timing. If it isn’t mission-critical or well-thought-out, consider delaying or deferring it. For a necessary asset, negotiate to acquire it under the most favorable terms, including, but not limited to, the use of available debt financing. It is essential to weigh the operating and tax benefits of the investment against the financing costs, especially in a challenging lending environment. Cash flow budgeting should account for increased borrowing costs as well as constrained credit availability. Look for extended terms from vendors for necessary investments.
7. Get closer to your bank.
Banks today are certain to be a lot more concerned with credit quality. As a result, they will need greater persuasion to lend money. Borrowing will likely come at a higher price, both in terms of interest rates and fees, and likely will include more restrictive covenants and require increased monitoring and transparency. In many industry sectors and geographic areas, new lending will be severely restricted, and you may struggle to refinance existing credit facilities. Banks are increasingly focused on the quality of their loan portfolios; their key concern is recoverability. You can expect a lot more scrutiny and a lot less latitude and flexibility from your loan officer.
8. Consider your financing options.
Make sure you understand your options for funding your business. Start with your incumbent lender, and consider alternative ways of structuring your current credit facility, i.e., term debt versus a line of credit. Understand default provisions in your current borrowing agreements. Based on your size and location, know all the local, regional and national senior lenders. Now is a good time to renew your relationships with technology-focused lenders, since they may be best- positioned to provide financing options. It may be worth considering other types of secured financing sources, such as leasing, asset-based lenders and factoring companies. In some locations, state and local government supported financing programs might be available. Other types of outside financing include subordinated debt, private equity and venture capital. If you have enough time and flexibility, these sources can help improve your capital structure over a longer period of time.
9. Keep an eye out for bargains.
As lending markets contract, some companies will have, or anticipate having, liquidity problems. Some of these companies will consider a sale transaction as a viable option. This feeling of uncertainty will drive many shareholders to seek an exit or a partnership with a strategic investor, rather than hunkering down and trying to weather the storm independently, thus creating buying opportunities at depressed prices. Be aware of opportunities where business valuations are falling and owners are looking for quick exits.
While the current economic environment is challenging, we believe technology companies that are well-capitalized, well-positioned and well-managed should see opportunities on the horizon. With careful planning and foresight, you might even be able to turn adverse conditions into an advantage.
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