CFOs will be challenged by shrinking EBITDA margins, according to new research
Is it time for CFOs to consider right-sizing selling, general, and administrative costs by taking a broader view of cost optimisation?
Is it time for CFOs to consider right-sizing selling, general, and administrative costs by taking a broader view of cost optimisation?
By 2027, weak demand and rising costs will shrink earnings before interest, taxes, depreciation, and amortization (EBITDA) margins by more than 30% relative to 2022, according to research from Gartner.
Most corporations will find it tougher to attain growth through 2026 as elevated levels of consumer debt and weaker-than-expected corporate cash flow dampen demand by reducing both discretionary and nondiscretionary spending.
Tepid GDP forecasts for advanced economies pegging annual revenue growth at the 2% range, labour costs in the U.S. and eurozone growing at approximately 5% annually, technology costs globally at 8%, and increases in other categories capped at the U.S. long-term expected inflation rate of 3%, can result in shrinking EBITDA margins over the three years.
“Ongoing uncertainty and instability will expose organizations to sudden cost surges in the coming years,” said Randeep Rathindran, vice president, research, in the Gartner Finance practice. “CFOs must intervene early to mitigate margin squeezes and confront spiralling expenses driven by the labour market, climate change, and digital transformation.”
Most companies will be unable to deliver the profitable outcomes investors have come to expect across much of the last decade, as the convergence of low rates, suppressed wages, and steady economic growth that enabled those results no longer exists. This will lead many organizations to seek out new strategies for hitting earnings targets.
Organizations will struggle to manage the gap between reality and perception on cost savings from continued investments in automation. Without true end-to-end process automation, any time savings from automation will be fractional (e.g., displacing one-third of a full-time employee but not whole one).
Traditional sources of capital funding such as bank lending or bond issues will become less viable as lenders and investors put greater scrutiny on near-term payback risk. Small or midsize margin-tight companies may struggle to cover interest expenses and become “zombie” companies confronting the prospect of bankruptcy or acquisition.
“Reliable strategies that CFOs have employed to mitigate similar market conditions in the past, such as selling, general and administrative expenses (SG&A) cost reductions, are no longer as feasible or effective given that expensive investments in digital technology and skills are necessary for transforming corporate functions,” added Rathindran.
In response to market conditions that will continue to shrink EBITDA margins for the foreseeable future, CFOs should recalibrate stakeholder expectations regarding financial models. Conducting a stress-test of financial assumptions around run rates for revenue, volumes, and costs can help identify potential gaps between reality and perception.
CFOs can consider right-sizing selling, general, and administrative costs by taking a broader view of cost optimization. This is not exclusive to just cost-cutting, but also cost-avoidance, cost-shifting, and value optimization to find savings while protecting critical organizational capabilities and transformation investments.
“CFOs can help their organizations overcome reliance on high-interest debt by broadening their view of funding sources beyond bank lending and corporate bonds,” said Rathindran. “Financial leadership should explore secondary equity issues, venture capital, and nondilutive financing options such as public-private consortia.”
Additional information is available to Gartner clients in the report Predicts 2024: CFOs Confront a New Cost Reality as Profits Take a Hit. Non-clients can visit Gartner’s Drive Profitable Growth page to find complementary research and strategies on this topic.