Start a conversation with an expert in the ‘cashflow’ field. Then count the seconds before they say, “Of course, cash is king.” This is the mantra of the post-GFC age.
However, there is a whole lot more to providing a tailored solution to keep the ‘financial blood’ coursing through your business.
In days of yore, when times got tough for a business, you turned to your friendly banker. Today there are more options, like debtor finance, receivables financing and invoice financing, and, let’s call them ‘lateral products’ which owner managers often lose sight of, in a crunch.
“The first two you mentioned,” says Wayne Goss, Scottish Pacific’s (Scotpac’s) head of business development, “are one and the same. Invoice discounting is typically used as a reference to an undisclosed debtor finance facility.
“Many companies still use overdrafts to provide working capital for their business; however, overdrafts are traditionally a fixed limit facility and lack the flexibility for a growing or seasonal business. Debtor finance, on the other hand, provides a flexible credit facility linked directly to sales volumes, which grow with business turnover.
“Consequently, debtor finance has the advantage over a bank overdraft in that it can provide businesses with greater financing during seasonal periods or periods of growth, without the requirements for real estate security,” says Goss, pointing out that “82 percent of businesses fail due to cashflow issues affecting their ability to meet expenses; yet 69 percent of these businesses are profitable”.
That’s not the only factor to make you sit up and take notice in this complex environment. While all the vendors and experts might agree ‘Cash is King’, it is the variety of departure points to reach the state of having consistent cashflow that can provide the major challenge for business owners.
“Financing business growth,” says Craig Brown, GM Lending, Lock Finance, “is a constant challenge. Since the GFC, cashflow management has become an even larger challenge for SME business owners.
“It was not just the economic fallout and the banking crisis; it was also when a significant change occurred in the stock management of a business and the flow-on-effect in the cashflow cycle of a number of businesses. Managing stock became more critical, so that a business was not sitting on slow-moving
or surplus stock.
“Consequently, more businesses ordered smaller but more regular quantities. So if sales slowed or grew they were in a position to react quicker, with reduced impact.
“They also looked to manage their creditor and debtor days more efficiently. The larger companies were able to seek longer creditor-terms and seek shorter debtor-terms. The SME was the one that basically had to wear the fallout and just take the terms dictated to them.
“So without a plan for managing their creditor, debtor and stock-turnover a business can very quickly run out of cash,” says Brown.
“Now that times seem better and more businesses may be in a growth phase they need working capital facilities and funders who can be as flexible as their cashflow requires. This means the ability to finance growing sales quickly and to provide additional working capital facilities.
“For SMEs, most working capital facilities are linked by traditional financiers’ security requirements which include the shareholder’s personal property, without placing a reliance on the debtors or stock of the company. This can restrain a business that is experiencing good growth,” says Brown.
“I should make the point too, that invoice financing facilities generally have no requirement for brick-and-mortar security and will grow as credit sales are made.”
You’re not a bank
RightWay Limited’s head of sales and marketing, Darren Eagle, raises a good point about credit. “Doesn’t everyone live on some form of credit these days? Who doesn’t have a mortgage and a credit card or two? For most of us, our bank owns most of our house for half our lives, so why do we care if we have the physical cash or not?
“The reason you should care is that SMEs are most likely to fail within the first three years of operation and one of the main reasons is they don’t manage their cashflow; instead they allow their clients to treat them like a bank.
“How well do you know your projected income? Who’s going to pay in the next two months and who isn’t? Can you afford to employ another person or buy another major asset? When is your busy season and do you have enough finance to cover expenses during quieter times? These should be questions that are constantly on your mind,” says Eagle.
He says so many business owners forget or don’t realise that when they are growing, almost ironically and ‘unexpectedly’, that is when cash is going to be even tighter.
“Even if your sales figures are great, it means nothing if you don’t collect them from your customers. So why would you let your customers use you as a bank? You are probably paying interest on that money and ultimately it could be used much more effectively – paying for something that will actually help your business to grow.
“It’s all very well working with your clients and helping them grow their business, but this doesn’t mean [your business] should finance that growth,” he says.
This is a theme which also resonates with Margaret Holmes, experienced founder and senior partner at Engine Room Chartered Accountants.
“Often still profitable, the business owner has usually lost sight of the important principle that ‘cash is king’, instead adhering to the principle that ‘growth is good’.
“As a business grows, its cash requirements grow, more money is tied up in stock and debtors, less money is available for paying creditors, wages and overheads. In a simple world the business collects the cash from their customers before they pay for the stock they sell.
“In a business where there are rapid stock-turns and carefully managed stock, and a good understanding of customers’ future needs, it may only need to fund the gap between paying for the stock and receiving payment.
“Sadly, in the real world it is much more complicated. In the worst case they might buy materials – often paying in full or partially before it arrives. Then processing them and adding value, paying wages and overheads as they go. Finally selling the product, to find they then wait 50 to 60 days for payment.
“A cash cycle of 200 days between paying for the goods and receiving funds from the sale is common.
“Each step can impact significantly on cash reserves, and needs to be carefully monitored.”
Unfortunately, says Holmes, many business owners continue to run their business by guesswork.
“A growing business needs a cash forecast and needs to use it to manage their business. As we saw in the recession businesses with large stock holdings are at a higher risk when there is a sudden downturn, and delays in clearing stock impact quickly on cash.”
Then there’s the unexpected
So far we have learnt that factors such as profitability, growth, stock movement, fixed overdrafts, etc, are no guarantee of success on their own and require careful management. But what happens when something out of the blue impacts your cashflow, such as a provisional tax bill.
That’s where innovators Tax Management NZ (TMNZ), who style themselves as ‘New Zealand’s oldest and largest tax pooling intermediary’ come into the picture, says CEO Chris Cunniffe – to enable SMEs to not only manage cashflow better, by making an arrangement to pay their tax later, but to continue to expand or reinvest in the business.
That’s almost in the ‘too good to be true’ category.
“Not so,” he says. “This is an IRD-approved product which lets owners shift provisional tax payments to a time that better suits them, without running the risk of incurring IRD late payment penalties – which can be up to 20 percent per annum – and ‘use of money’ interest of 8.4 percent.
“We’ve been in existence since 2003, and since then have helped more than 25,000 SMEs save more than $70 million in IRD compliance costs. Put simply, the money owners would have otherwise paid to the taxman can be used to reinvest or grow their business.”
So how does it work?
“An owner pays TMNZ a one-off, tax-deductible interest amount. This interest amount is based on the amount of tax financed and period of maturity. It would cost $290 to defer a provisional tax payment of $10,000 for six months.
“Not a bad trade-off given the amount of working capital that becomes available as a result.And, it does not affect existing credit lines and no credit checks or security is required. Our rates start from below six percent, making it cheaper than many other traditional forms of finance, such as using an overdraft or unsecured loan.
“It is also easily extended and if all of the tax being funded turns out not to be required, you do not have to pay for it,” says Cunniffe.
‘Must dos’ and technology
What are some of the ‘must dos’ to ensure the continuing reign of cash?
“A business owner needs to be able to implement controls and policies for the management of their cashflow, debtors and credit control,” says Lock Finance’s Brown. “This is best done by understanding their working capital cycle and implications associated with obtaining credit and extending credit. Careful management can reduce their working capital funding requirement. Getting proper advice that takes into account all aspects and not just the cheapest option
Over the years, technology has played a major role in the understanding and demystifying of these invoice lending products, by adding visibility and allowing efficiencies.
“Technology is also playing a significant role in cashflow management with financial modelling software, which shows the business owner the benefit of reducing debtor days by one day or week, and [dare I say it] delaying payment to creditors; also by improving your stock-turn.
“Whether this is shown by figures or by graphics, it is now something that most business people can weasily understand without needing an accountant to interpret for you,” says Brown.
Naturally, experienced chartered accountant Margaret Holmes has her own views.
“Fortunately for SMEs, the cost of systems to manage their business has reduced significantly with the advent of subscription software. Products like Xero mean there is no excuse for not understanding how your business is performing.
“There are even Xero add-ons to help you collect your debtors. Quality stock management systems are now affordable, and enable businesses to see which stock is clearing slowly, then take action to move it along,” says Holmes.
We’ve already covered the impact of provisional tax, but general tax on profit is another aspect business owners often forget about.
“Just because you make a profit of $100 it doesn’t mean you can spend it all,” says RightWay’s Eagle. “Most likely you will need to pay $28 to $33 of that in tax. Owing money to IRD is designed to be an expensive finance option – they charge 8.4 percent interest and can sting you with monthly penalties as well.
“So don’t spend it all. Hold back a portion of your sales and put it into a savings account to pay for tax. Even better, talk to your accountant and get a proper cashflow projection that you actually use and keep up to date. You need to know when the ‘cash droughts’ are about to hit so you can plan for them and get through.
“Finally, actively chase your clients to pay up, even if it means ringing them once a week,” says Eagle. “Get them to commit to a payment timeframe. Set terms of trade in your invoices. “Give yourself the right to charge them interest if they don’t pay within an agreed period. You need to cover the interest you are losing out on – and a little bit more for running around after them.
A good way to think about your debtor management is the big link between time and appreciation. “As time passes, the amount of appreciation your client has for the awesome service you provided decreases. So as soon as you finish a job for your client, bill it.
“Don’t wait until the end of the month where they’ve already had the benefit of your services for weeks and the appreciation has diminished sometimes to the point they feel they have paid too much. If you bill quickly then they will still appreciate the good job you’ve done and may feel obliged to pay you sooner.
“With Christmas around the corner it’s even more important for you to budget your cash and manage your receivables,” advises Eagle.
There’s a timely ‘stocking filler’,
if ever there was.
›› Kevin Kevany is an Auckland-
based freelance writer.
Email [email protected]