Geopolitical Uncertainty and Cash Flow Management
The Ukraine conflict, the pandemic's lasting impacts, inflation, and other macroeconomic and geopolitical issues are all having an immediate effect. As geopolitical concerns are increasingly pushing and pulling on financial markets worldwide, companies worry that future cash flows won't be adequate to take advantage of investment possibilities. The uncertainty surrounding political leadership, policy, and foreign relations being the driving factors behind financial market volatility and increased geopolitical risks becoming the new normal, let's take a closer look at how these risks could impact cash flow management.
Impact of Geopolitical Uncertainty on Cash Flow Management
The market may resemble the early stages of the pandemic two years ago in terms of the lack of clarity that CEOs and investors experienced because of the conflict and the surge in energy costs it has unleashed, among other factors. However, the current situation is more like the latter months when it became evident that COVID-19 was creating winners and losers rather than taking everyone down evenly than it was in the early stages of the pandemic. As companies assess projects based on two factors - cash flows and discount factors, it would be a mistake to write down valuations to zero in the notion that determining a fair value is not conceivable, even for those that have exposure to the struggling Russian oil and gas sector, which is suffering from Western sanctions and government-mandated disinvestment.
Also, concerning company cash holdings, investors hold two opposing opinions. Firstly, because corporate cash holdings are more crucial to the survival and investment of businesses, they tend to place a larger value on cash. If businesses don't have enough cash on hand, they risk losing out on investment possibilities, and the high level of uncertainty makes getting external financing more expensive. Secondly, investors may realize that company managers have a chance to increase cash savings and overinvest in unprofitable ventures during periods of high geopolitical uncertainty.
Cash flow management needs to be focused on central principles of not only accounting and budgeting but also should tie up to the overall vision of the company and short-term goals. So, if the company sees pockets of opportunity, then investing in new projects during turmoil becomes a necessity. Running a both top down and bottom-up analysis is critical.
Geopolitical risk shocks are known to have a negative impact on the real activity as well as a capital flight to safety. In response to geopolitical risk, businesses reduce their capital expenditures. For companies with more permanent investments and international activities, this effect is stronger. Investments seem to be more affected by geopolitical threats than by geopolitical acts, maybe because actions are seen as relieving uncertainty. Changes in geopolitical risk have no adverse effects on dividends, another way businesses utilize their income, suggesting that geopolitical shocks have finite half-lives. When businesses confront significant geopolitical uncertainty, corporates may use this as a chance to reserve more cash for the proverbial rainy day.
Feel free to consult RSM UAE to discuss your geopolitical concerns. RSM is one of the world’s leading audit, tax, and advisory service networks, recognized for innovative solutions across the globe. RSM professionals can help undertake the granular analysis of the impact of geopolitical uncertainty on cash flow management on your company.