CFO challenge focus: Macroeconomics

Macroeconomics is a branch of economics relating to the performance, structure, behaviour and influences affecting an economy as a whole – from regional, to global in scale.

Regional and global fiscal and monetary policies have a role in determining structure and steering macroeconomic performance, but geopolitical, environmental, and cultural influences are harder for governing bodies to control, if indeed at all.

Chief Financial Officers are faced with forecasting financial performance, growth opportunities, and risk management against the backdrop of these macroeconomic pressures. Decision-making for profitability in the short-term can be quickly derailed by macroeconomic changes, such as those seen from the invasion of Ukraine in 2022.

CFOs need to structure supply chain, distribution, and business partner relationships to defend against the worst macroeconomic impacts, while operating in a sufficiently agile manner to capitalise on macroeconomic opportunities, such as differences in consumption, interest rates, and exchange rates between countries.

Current status

In a world recovering from the COVID-19 pandemic, but faced with mounting geopolitical tensions, environmental pressures, and a mismatch between projected population growth and associated food and energy needs, macroeconomic factors are likely to have an increasing impact on the performance and prospects of every business.

While CFOs and other finance leaders grapple with initiatives to address regional demands such as regulatory pressures around ESG, they also need to be keenly aware of how macroeconomic factors affect their business and remain agile enough to adapt accordingly.

Whether considering long-term macroeconomic impacts, such as climate change, or short-term and less predictable changes, such as the war in Ukraine, CFOs need to monitor the impact on day-to-day business, and then benchmark and track the right metrics in financial reporting to identify and apply the most appropriate operational changes as quickly as possible.

How macroeconomics affects your business

Macroeconomic factors involve a complex interplay between production, investment, and consumption, but the 2020s look set to be heavily influenced by the following aspects of macroeconomics.

Inflation

Inflation is rising globally.  Government spending rose drastically, in most countries, to combat the coronavirus pandemic.  Monetary policy has adapted to inject cash to support this spending and this inevitably leads to inflation.

It’s not just the cost of the pandemic that is driving inflation. Energy and material scarcity, combined with increasing demand and geopolitical limitations on supply, play a significant role in driving inflation too.

While governments, and most businesses, benefit from a degree of inflation, the double-digit inflation seen in many countries can pose a threat to economic growth as spending drops and funding requires a higher rate of interest repayment.

Energy

Putin’s invasion of Ukraine has resulted in massive changes to oil and gas distribution globally.  With limitations on supply, the price of fuel has risen significantly.  Energy costs per kilowatt hour have risen as a result, regardless of the source – renewable or not.

Rising energy prices impact every business and consumer directly.  Production and distribution costs need to rise in line with the underlying energy price increase, to support the cost of energy used at every stage.  These costs are then passed on to consumers, further driving inflation.

Businesses that can reduce their energy consumption will stand to gain competitive advantage, through the ability to price their products and services lower and/or command a higher margin, than less energy-efficient alternatives.

Unemployment

Although unemployment is considered as a significant macroeconomic factor, unemployment rates remain low, in late 2022, across much of the world.  For example, the UK recorded the lowest unemployment rate (3.5%) since 1974 in the three months to August 2022. It is expected that these figures will change considerably in the next few years, with the UK projecting a 40% rise in unemployment (to 4.9%) by 2024.

As inflation rises consumer spending will drop, resulting in businesses laying off staff as demand for products and services decrease.  The resulting combination of high inflation, slow growth and high unemployment is termed stagflation.

The growth in automation across all industries will enable businesses to maintain, or increase, output with lower levels of employment, but without a balanced growth in new jobs unemployment will rise.

Businesses struggling with the retention and development of skillsets in current times may expect higher unemployment to present a greater pool of human capital to choose from, but the decline in demand for products and services is likely to outweigh the improvement in recruitment in the business environment.

Consumption

Consumption is the act of using resources to satisfy current needs and wants, as opposed to investing, which is spending for acquisition of future income.  When consumer finances become stretched, such as in a recession, the overall levels of both investing and consumption drop.

In most countries consumption is the most significant component in calculations of GDP, ranging from 45% of GDP to 85% of GDP.

Consumption begets sales, so a reduction in consumption is bad news for the economy and businesses as a whole.

International trade

International trade is implicit within the majority of business supply chains, if not customer accounts, too.  Geopolitical tensions, war, and viral pandemics have all taken their toll on international trade in recent years.

Businesses that have selected international supply chain partnerships based on the premise of cost reduction may be faced with the need to re-evaluate their choices, restructuring supply chains to prioritise resilience to shocks in future.

Businesses selling internationally need to comply with an increasingly complex range of invoice delivery and tax compliance challenges, particularly within Europe.  The paradigm of electronic invoicing has reduced print and delivery time and cost, but replaced this with the need for connections to a range of invoicing portals using specific delivery formats and continuous transaction controls (CTCs).

International finance

Financial relations between countries have come under strain in recent years as the increase in political and environmental risks have sharpened geographical divisions.  As inflation takes hold globally at different rates, exchange rates, capital markets, production capacity and demand will vary from country to country, presenting both opportunities and risks. The more agile and adaptable businesses are in their supply chains and distribution, the more likely they are to outperform more rigid competitors.

Mitigating macroeconomic pressures

Macroeconomic policy is usually implemented through two sets of tools: fiscal and monetary policy. Both forms of policy are used to stabilize the economy.  Businesses are, to a degree, at the mercy of the macroeconomic policy and economic performance of the countries in which they operate.  However, certain precautions and preferences are adopted by businesses in the interest of reducing exposure to macroeconomic risks.

The role of the CFO, amongst C-suite executives, may be to apply the finance function to value creation for stakeholders, but it is also to protect from financial risks such as macroeconomic impacts.

Today’s CFOs need to make strategic decisions to limit the impact on business performance from macroeconomic factors. Finance teams should consider more strategic procurement initiatives to optimize cash flow and supply chain resilience. In these turbulent times, business models need to adapt to safer — not necessarily leaner — inventory management, calculating ROI in terms of current market valuation of assets, rather than historical values.

CFOs also need to have a keen awareness of changes to central bank announcements to plan ahead, rather than try to adapt in real-time.

Financial leaders now have a greater incentive to focus on resilience than bottom line performance. The benefit from investments in new technologies, service providers, and processes for competitive advantage may quickly be wiped out if there is insufficient resilience to macroeconomic changes.

Mitigating macroeconomic challenges also comes at a time of market, industry, and
supply chain volatility combining to create unprecedented levels of uncertainty for business leaders.

These pressures, as well as ongoing complexity in B2B commerce, mean that CFOs need to look at their finance ecosystems holistically in order to drive predictable, profitable growth.  We explore this topic in more detail in a 15-minute webinar you can access here – The Role of the Modern CFO .