Forecasting in a COVID-19 world – Practical solutions in an uncertain environment

As part of the 30 June reporting period and with the beginning of a new financial year, companies are undoubtedly focused on many aspects of the future, one of which is likely to be how to approach budgets and projections for business planning, capital requirements, and impairment testing. Forecasting 3-5 years in the future has never been an easy task even in normal times, however, the current environment means the crystal ball is particularly hazy at the moment!

Whilst share markets have recovered most of the losses experienced subsequent to the onset of COVD-19, the economic implications appear likely to have a much longer tail, particularly once government stimulus measures dissipate and the real economic impact of the crisis takes hold. We anticipate that due to this uncertainty, any cash flow projections are likely to be subject to more scrutiny from board members, auditors and regulators whilst at the same time being more complicated and subjective.

Forecasting tips

Based on discussions with clients and preparing valuations based on long-term projections in the current environment, we thought it would be useful to share some quick tips and observations about how we are approaching the preparation of projections in the current environment.

First of all, when preparing forecasts, we recommend considering the key assumptions and/or scenarios to utilise and obtain feedback from directors and other key stakeholders well before a detailed model is prepared.  This can be captured in ‘Key Assumptions on a Page’ which allows for key factors to be summarised and feedback obtained from key stakeholders such as the board and auditors.

In addition to the normal process of identifying key business drivers and assumptions (such as market/price growth, volume drivers, cost drivers, earnings margins, capital investment requirements, working capital flow and tax profile, etc.) some of the factors that need to be considered currently that have not been in the past may include:

Factor Considerations
Macro environment
  • What is the shape of the recovery (pick a letter: V, U, W, L or perhaps the Nike swoosh-shaped recovery)? What is the correlation of business / industry revenues with macroeconomic factors?
  • For companies with customers or supply chains operating in international markets or priced in foreign currencies, determining future foreign exchange assumptions can be a critical assumption.  Forward rates (rather than spot) should be used unless amounts are hedged.
Covid-19 restrictions and other implications
  • Duration of lock-down and social distancing restrictions. For example for hospitality, live events and other businesses, social distancing measures limit revenue potential. Determining the path to a ‘normal’ environment (and what is the new ‘normal’ in terms of capacity, demand, etc) is therefore a key assumption driving value.
  • Is a ‘second wave’ likely? If so, what implications are there for the business of a winding back of lock-down measures and restrictions? Recent experience in Victoria demonstrates that this is a real risk with significant consequences.
  • Is the business impacted by foreign and domestic travel (business, leisure or otherwise)? If so, assumptions need to be made for when travel resumes to a ‘normal’ level and the trajectory. For example, for businesses dependent on international visitors (such as tourism, higher education, live events, etc), views need to be taken on when international borders will open to specific regions.
Other considerations
  • Is the supply chain (or components thereof) located off-shore? If yes, when is this accessible and are there volume constraints? Are there any additional costs associated with importing?
  • Impact on input costs due to changes in commodity prices such as oil, coal, etc.
  • Does the company qualify for any support from government, landlords, etc? Is there a defined timeline for these measures?

More than ever, there is probably no right or wrong answer. For 30 June impairment testing, the critical aspects to get boards and auditors across the line will be documenting (and agreeing) the key assumptions underpinning your cashflow model. For businesses that are experiencing uncertainty due to the economic and other implications of COVID-19, it is also important to ensure that adequate consideration is given to the understand the ‘best’ case and ‘worst’ case scenarios at a minimum so that the goal posts are established.

Impairment resources

We have been more involved with clients in recent months in providing a framework and models for projections for impairment testing and for other strategic purposes. For questions or assistance, don’t hesitate to contact us.