Think Tank

COVID-19: Lessons in financial risk management

Neeraj Basur, Group Chief Financial Officer at Blue Star Limited

"Life is a series of experiences, each one of which makes us bigger, even though sometimes it is hard to realize this. For the world was built to develop character, and we must learn that the setbacks and grieves which we endure help us in our marching onward" – Henry Ford

I couldn’t agree more with the above quote of Henry Ford in the current global context where the world is gasping and grappling to overcome Covid-19 pandemic impact. This black swan event has also impacted how enterprises arehaving tocopewith the immense turbulence caused in the management of their finances. Financial risk assessment and mitigation will never be the same anymore and will assume a different character going ahead.

Under the lockdown situation, operating cash flows of every business are drying up rapidly with the operations coming to a standstill. Aggravation of cash flow stress during the lockdown phase and for some time thereafter is quite inevitable. Enterprises which were highly leveraged before this event unfolded would be tremendously constrained to stay afloat while those businesses who had surplus cash on their balance sheet though somewhat better off, will also undergo the same pain.

In these unprecedented times, can the financial managers draw lessons from an analogousenvironment that practicesrisk management activelyand where the risk mitigationinitiativeshave matured and evolved over time?

I could think of risk management protocols followed by the aviation sector as a relevant parallelon matters of safety and disaster management.

In-flight safety announcements, though sound monotonous and boring, have life-saving potentialin the event of an accident or an unforeseen mishap. Interestingly, some of these in-flight safety protocols have a parallel in ‘financial management’ terms, which could enable mitigation of financial risks arising from severe financial turbulence arisingfrom a pandemic event. I will elucidate a few of these in-flight safety announcements to illustrate the point.

There are several emergency exits on this aircraft. Please take a few moments to locate your nearest exit. If we need to evacuate the aircraft, floor-level lighting will guide you towards the exit
so that you can swiftly exit the aircraft should there be an emergency. In financial terms, assess the sufficiency of banking lines of credit when the going is smooth and operations are normal. This will enable you to have in place a plan to access funds in an emergency (and quickly evacuate from the immediate financial distressin the short term). You will not have the luxury to get your banking credit lines assessed and sanctioned in a crisis.

When the seat belt sign illuminates, you must fasten your seat belts
you would not want to be tossed around, risking injury, if the aircraft is flying through turbulence. When the markets are disrupted and the business is volatile, tighten the credit assessment (seat belt) norms for all the customers. Once the pandemic subsides, the credit profile of customers might change, may be forever, for some. You would not want a potential deterioration of your customer’s credit profile to impact the operating cash flows in these uncertain times.Tightening seat beltsin a turbulent phasefor a business will also involvesecurely tighteningfixed operating spend, making each dollar of spend more effective.Cutting down fat and flab would be ever so important for anybusiness to spring back to life, with agility,when the new dawn of operational activity emerges.

In the event of a decompression, an oxygen mask will automatically appear in front of you. To start the flow of oxygen, pull the mask towards you
so that lives can be saved while an aircraft in a distress situation may still need some time to land safely. The most critical lesson this pandemic event has taught financialmanagers is that of maintaining solvency capital on the balance sheet. So far, business entities have focused on raising fixed capital (for capital expenditure) and working capital. Only regulated businesses such as banks and insurance companies are traditionallymandated to maintain solvency capital on their balance sheet.The same concept will now need to be extended to the unregulated sectors.

Quantifying and retaining solvency capital will ensure that in a financial emergency, cash (oxygen forbusiness) can be accessed at a short notice by simply dipping into the solvency capital (the oxygen mask). Normally a business may never need to access its solvency capital, just as we might never need to pull those oxygen masks, but just in case you needto, this safety net will help bailout.

A life vest is located in a pouch under your seat or between the armrests. When instructed to do so, open the plastic pouch and remove the vest
On January 15, 2009, Captain “Sully” landed an Airbus A320 in New York’s freezing Hudson River following a bird strike induced loss of both the engines. All 155 passengers and crew on board US Airways Flight 1549 survived. I am sure these passengers and crew would remember the importance of those life vests, throughout their lives.

In a business situation, where are these life vests who can save the business from drowning? The answer is –investorsand bankers. Relationships and rapport cultivated with the investors and bankers during normal times will determine whether they will extend you the much-needed life vest in the times of a financial crisis. The strength and depth of these relationships -life vests will determine how strongly the business enterprise can navigate a water landing situation.

This is a non-smokingflight. Tampering with, disabling or destroying the smoke detectors located in the lavatories is prohibited by law
Flying safely is all about following protocols, discipline and rigorous standard operating procedures. In good times, each business needs to define its own “no-smoking” rules to ensure that business is operated profitably and working capital gets managed tightly. These “no-smoking” rules in an operating environment will relate with the resilienceof the economic model of a business that can sustain shocks, margin and profitability profile that gets converted into cashquicklyand not permitany non-performing asset to creep up on the balance sheet. A “non-smoking” organization will invariably have a healthy balance sheetand withstand any futureblack swan shockslike Covid-19,betterand with greater resilience.