As most CEOs are executing their plans to keep their people safe, we must also lay plans to keep our businesses alive so when normalcy returns our people will have jobs to return to and our customers will be able to depend on us.

In my previous article, I wrote about how to lead employees through this crisis. But as leaders, we must live in the future while our teams execute in the present.

An economic downturn is barreling at us. The only way to know how to prepare our businesses is to make assumptions about how bad it will be and to reflect those assumptions in a proforma set of financials going forward 12 months from now. Only by looking at the company’s financial health 4-8 months into the future can we know what to do now—how many to lay off or furlough, how loudly to demand reductions in fixed costs from landlords or others, what expenses to cut. Midsized companies are too large to do this by “feel.” I also believe that many companies will have to make heart-wrenching choices to stay viable, laying off good people and scrapping what seemed like great ideas. To make those types of decisions quickly requires some quality analysis to push us to make the difficult decisions.

The best practice is to do a financial model powers scenario planning by looking at worst-case, middle-case, and best-case scenarios. Once these scenarios are complete, the leadership team must make judgment calls about the risks in each case. Cutting too much has risks. Not cutting enough has risks.

The hope is that for all the scenarios, some actions are essential to take now. Those are easy decisions.

Here are the steps:

1. Create your model, typically four sheets in excel: one for the income statement, one for the balance sheet (you MUST do both), one to list all your employees and their monthly cost, and one for your variables/assumptions (e.g.. DSO, inventory turns expected, etc.). Many rows (except fixed costs) should be formula driven to the sales number and cash should be the balancing account. These models (when automated) require someone experienced with strong Excel and finance skills to create them.
2. Decide on your three scenarios. From my reading of the situation and my experience, I’d suggest these assumptions (apologies for being so grim):
   1. Best case: Non-essential business facilities closed for 4 weeks; essential businesses have sick staff members, partial quarantines. Suppliers’ response slowed by 25%; customer payments delayed by 25%; productivity of employees reduced by 20% (working at home/sick/distracted by sick parents/news), fixed costs stay fixed, banks only slightly tighten credit.
   2. Middle case: Non-essential business facilities closed for 3 months; essential businesses have sick staff members, partial quarantines. Suppliers’ response slowed by 50%; customer payments delayed by 50%; productivity of employees reduced by 35% (working at home/sick/distracted by sick parents/news), fixed costs reduced by 15%, banks tighten credit where weak companies are threatened/lose credit lines.
   3. Worst case: Non-essential business facilities closed for 8 months; essential businesses have 30% sick staff members, ongoing partial quarantines. Suppliers’ response slowed by 75% (some collapse); customer payments delayed by 70%; productivity of employees reduced by 45% (working at home/sick/distracted by sick parents/news), fixed costs reduced by 25%, banks tighten credit where few companies are allowed commercial borrowing increases, many receive default notifications from their banks.
3. Adjust the variables in your proforma to reflect each of the scenarios above. Your model should allow variables to adjust by month. For example, your DSO (days sales outstanding) variable might be different in each of the 12 months you are forecasting. This step is not just for the finance person. The leadership team will have to make judgements about the right number for the variable. For example, “Given our customers’ current average DSO of 40 days, and given their situations, in May, what can we expect from them in terms of payment? 60 days? 70 days?” Input that number.
4. Stand back and look at the three proformas. If you’ve used cash as your balancing account, you’ll see cash go down, then negative. That negative amount is your financing requirement to stay solvent. Examine each model and think it through to confirm that you believe the number to accurately reflect the future, given that scenario. This will be hard since we have such an unusual and grim situation at hand.
5. Start making your cuts in each model to turn cash to positive, or to an amount that you are confident you can finance. For example, you might choose some people to lay off, or to close an office, or even to break the terms of your lease and stop paying rent.
6. Looking at the three scenarios, make quick decisions about those adjustments that will be required in all cases. Execute on those ASAP. Then come back to the harder debate: should you cut further to accommodate the medium-case or the worst case?

I just got off a Zoom call with a client who followed this procedure perfectly. Given a downgrade of revenue forecasts (40% below normal), they reduced their monthly projected losses from $164,000 per month down to $41,000 per month and given their cash on hand, they could absorb those kinds of losses for up to 11 months. They went down a spreadsheet of employees with their costs shown and made other cuts to expenses and then looked at their bottom line to see the cumulative impact. The model was built by their finance leader (who is an owner as well), presented to the four partners to make the decision and was immediately followed by a full leadership team meeting to move into execution. Most furloughed personnel will be notified today. Smart.

I don’t know if the suggestions I made for worst, medium and best case are the right ones. And you and your team will make a host of other assumptions that will affect your model. We don’t know the future. But the only way to reduce the complexity of this situation is to combine all your assumptions into a financial model for your business and see what the future may portend. It will make your decision, whatever it is, more informed. Some of you will choose to act on your best case—and I hope you are right! Others may act on the worst case. No one can tell you what is right or wrong, but I believe you’ll make a better judgement if you’ve done your scenario planning.