Accounting and financial management in economic uncertainty

By Laura Hay, CPA, CAE, OSCPA executive vice president

Facing rising interest rates, inflation and market instability, businesses are experiencing shifting accounting and financial management priorities.

Changing environments can significantly impact financial statements, risk management strategies and investment decisions. The CPA profession demonstrates leadership in effectively navigating complexity in accounting, reporting and financial management during periods of uncertainty.

Some rising priorities resulting from this environment include:

Cash and working capital

Organizations are renewing focus on working capital management and cash flow. After many years of low interest rate environments with essentially “free” cash, financial leaders again need to balance working capital and necessary investments in the business. Challenges may include:

• Identifying and addressing assets “trapped” on the balance sheet based on decisions made in lower interest rate environments

• Re-tightening metrics for managing receivables, inventory and payables to a “cash flow culture”

• Using technology and reporting improvements to measure KPIs and support decision-making

• Managing liquidity for necessary investments in business model changes while sustaining historic business lines

• Projecting cash flow and discount rates used in prospective financial information

• Responding to changes in cash management based on developments in the banking sector

Asset valuation and impairment

Higher interest rates and inflation may influence the fair value of assets and trigger impairment tests. Changes in estimated future costs of materials, labor and commodities may influence estimated costs of production.

Financial reporting issues include:

• Changes to inputs to valuation models

• Changes in investment asset valuations

• Changes in deferred tax asset valuations and assessments of realizability

• Changes in measurement for financial assets and estimates of credit losses

• Changes in assumptions used in the fair value measurement of derivatives, including counterparty risk or collateral value

• Changes in assessments of hedge effectiveness

• Changes in intent to hold assets to maturity

• Asset impairments, including the assessment of goodwill, property plant and equipment, right-of-use assets and net realizability of inventory

• Valuation in business combinations

Capital

Borrowing costs eligible for capitalization will likely increase. Projections may not be able to assume that capital expenditures will be equivalent to depreciation expense.

Liabilities

Rising interest rates can change the incremental borrowing rate used to measure lease liabilities.

Retirement obligations and postretirement benefits

Inflation and rising interest rates may affect cash flow, rate of return and discounting assumptions for retirement obligations and postretirement benefits.

Debt

Companies need to consider the effects of slowing economic activity and developments in the banking sector on debt and credit availability. Considerations include:

• Changes in financing arrangements

• Changes in the classification of debt

• Potential impact on debt service obligations and debt covenants

Revenue recognition

Rising interest rates may affect the assessment of the financing component of a contract, increasing the interest income or expense portion.

Currency fluctuations

Entities may need to consider the impact of highly inflationary economies, including the utility of the functional currency applied.

Disclosures

Disclosure considerations include:

• Disclosures about critical accounting policies

• Material changes in internal controls over financial reporting

• Changes to liquidity disclosures or risks

• Changes to fair value disclosures, including changes in hierarchy assessment

• Disclosure of the nature and extent of risks arising from financial instruments and related mitigation efforts

• Changes to credit agreements or debt terms

• Material changes in contracts with customers or suppliers

• Changes in significant estimates

• Business concentrations

• Potential supply chain disruptions

Management’s discussion and analysis

Companies including management’s discussion and analysis should address changes in financial condition and results of operations resulting from the current economic environment, including unusual or infrequent events or significant economic changes. They should also disclose known trends or uncertainties that have or are expected

to have a material effect on results of operations, revenue, liquidity or capital resources.

Business implications

As financial managers assist organizations in maximizing resilience and staying on track toward long-term growth goals, some business considerations include:

• Re-examining contractual agreements and strategies, including lease agreements, contracts linked to floating interest rates, hedging strategies and debt agreements

• Accelerating transformation and deployment of digitization, cloud solutions, data analytics, cybersecurity, and AI

• Heightening data-driven scenario planning, in a period of more complex risk scenarios, to model potential impacts of market factors

• Prioritizing human capital investment to drive growth goals, including strategic hiring and targeted upskilling for people with specialized skill sets in analytics and insight, forecasting and scenario planning, operational efficiency and effectiveness, and risk management

• Implementing capital discipline, investing selectively consistent with the organization’s business transformation strategy

• Revising pricing models, balancing with long-term customer demand, and incorporating inputs such as supply chain and resource risks into valuation models

• Fine-tuning compensation strategies driven on outcomes

• Integrating financial and non-financial reporting systems

During periods of rising interest rates, inflation, and market instability, CPAs lead in addressing business accounting, financial reporting and financial transformation challenges. Properly navigating these challenges is essential to maintain transparency, make informed decisions, and provide stakeholders with accurate information about an organizations’ financial health. By addressing issues related to asset valuation, debt management, foreign operations, revenue recognition, and risk management, businesses can better weather economic uncertainty and position themselves for sustainable growth. It is crucial for organizations to stay agile and alert, seek professional advice when necessary, and maintain a proactive approach in adapting to the changing economic landscape. In a period of more complex risk scenarios, heightening data-driven scenario planning to model potential impacts of market factors.

Laura Hay, CPA, CAE, is the executive vice president of The Ohio Society of CPAs and the staff liaison to the Accounting, Auditing, Professional Ethics Committee and Peer Review Committee. She can be reached at Lhay@ohiocpa.com or 614.321.2231