Solving the cashflow conundrum

Business having cashflow problems? Sometimes it is just a matter of doing something different.

Every business owner trots out the “cashflow is king” line when challenged to define his/her most important criteria for surviving in the commercial world.
Others will tell you cashflow is essential for financing business growth without “getting other partners in”.

The more adventurous swear by the use of multiple credit cards, even using the IRD, as the means to get over a short-term ‘hump’ and avoiding tying up personal property as security.

Craig Brown, GM Lending, Lock Finance has his own interesting take on cashflow and how important it is, whatever stage your business is at.

“Cashflow management is a very tricky beast. Also, no one business’s cashflow is the same,” he says. “Having a strong cashflow requires a number of ingredients such as supplier payment terms; client credit terms; credit management skills; and having appropriate funding facilities which, like a cake, need to be used in the right mixture to end up a success.

“You may be able to manage one or two of these, which may improve your cashflow, but some businesses do not have the option to decide when they pay their main supplier. Or dictate payment terms to their larger clients.”

Studies from ANZ Bank have shown that 82 percent of SMEs fail due to cashflow issues, while 69 percent of these businesses are profitable. Read it again, and it’s an even more frightening statistic.

The statistics paint a gloomy picture and should be a major warning to all in business.

“There’s no easy answer to managing the need for cash in a growing business,” says Philippa O’Mara, a chartered accountant at the Engine Room. “Knowing that your business can’t grow any faster than its cashflow allows is a good start, followed closely by setting and measuring cash targets.

“It is almost always the case that a business experiencing rapid growth is starved of cash, whereas a long-established mature business, which experiences only modest growth, is usually an excellent cash-generator.

“For new businesses, building a cash-cushion in the early stages is one of the most challenging aspects of business management,” says O’Mara. “Staying conservative and planning for cashflow challenges in the early stages of a business; keeping drawings to a minimum by remaining in paid employment as the business starts, or seeking investors (taking note of my On Accounts ‘debt-to-equity’ column in August’s NZBusiness) will all help.

“It’s about ensuring the client cuts its coat according to his/her cloth too. We often have to persuade clients that, just because they ‘need’ ‘X-amount’ of dollars to live, doesn’t mean they should draw out of the business, in its early stages, before it has developed its cashflow. We made a plan with one client buying a business, which had a long growth-lead-time, that at least one of the husband-and-wife team would work outside the business for a period, so they did not rely on the overdraft to pay living expenses.

“The overdraft would be needed when trading actually started. They are now cash-positive and growth has not been hindered by lack of cash,” O’Mara says.

Craig Brown believes SMEs, particularly, need to be progressive and innovative in finding solutions to this challenge.

“As a business you do not need to keep looking at cashflow the same way as you used to. Sometimes it’s just a matter of doing something different. Make yourself aware of the changes in technology, management tools and alternative financing arrangements available to allow your business to rise as it should,” says Lock Finance’s chief lender.
Wayne Goss, head of business development at Scottish Pacific Business Finance, picks up the theme.

“With staff wages, IRD expenses, raw materials to purchase and various unexpected costs arising regularly, it is imperative for businesses to have cash readily available to cover these expenses. Suppliers will not provide credit terms if you have an extended payment cycle; experienced staff are unlikely to stay on board if wages are delayed; and the business’s reputation in the marketplace will inevitably weaken.

“By contrast having a strong cashflow provides quick access to funds to assist with working capital requirements which arise on a day-to-day basis. Having this working capital readily available is essential for keeping creditors happy and can work to establish better pricing on raw materials; remove staff concerns regarding their wages; and work to develop the company’s reputation.”

Signs of trouble
What are the most common signs of cashflow problems? According to Wayne Goss they are:

• Creditors falling into 60–90 days. “Although on the surface this may not appear crucial to business survival, businesses with a strong cashflow cycle are able to take advantage of prompt payment discounts, secure lower pricing and establish themselves as an ideal customer to forge strong relationships with suppliers.”
• A delay in fulfilling orders. “This is possibly a negative sign; that a business is suffering cashflow issues. If the business is profitable, but short of capital to fulfil an order, many customers will go elsewhere to find a more timely solution.
• Missing deadlines for statutory payments to the IRD. “Late payments can suffer penalties and additional interest charges, costing the business. And if the situation becomes dire the IRD can put the business into liquidation.”

Goss says he isn’t a fan of the credit card/ IRD solution either. “It is inherently risky. Although bouncing from credit card to credit card may work acceptably in the short term, as the business grows or as unexpected expenses arise the credit limit will become stretched, putting cashflow pressure on the business.

“Furthermore, if the payment deadline on credit cards is missed, the interest rates can be in excess of 20 percent per annum.”

At Lock Finance, Craig Brown says most of the businesses referred to them are growing, but do not have the right mix of ingredients.

“One solution to this is to find the right cashflow finance facility. Wouldn’t it be great to have a solution that grows as your sales grow; does not require you to look for additional equity or sell part of your business; does not require you to put your house up as security; and means you do not need to change your loan terms, if you cannot or do not wish to.”

He cites the example of a client in the recruitment industry providing permanent placements, but looking to grow its revenue by starting a temporary contracting side.

“To do this the business needed to fund a growing, weekly contracts’ wage bill. The company had no ability to extend their contractors’ wages beyond weekly, nor did they have the clout to make their clients pay quicker than the 20th to 30th of the month following invoice.

“They needed to finance a growing weekly wage bill for four to six weeks. The more successful the temporary placement side of the business became, the larger the weekly wage bill became.

“Our debtor finance facility enabled them to release funds weekly against their debtors so they could pay their contractors weekly.”
Brown says the upside was:

• As the business grew, so did their facility for the client.
• They did not need to provide any additional security as the facility grew (the invoices were the security).
• They did not need to seek a business partner to inject any cash/equity; and
• They did not need to make any changes to their customer payment terms.

Involve your accountant
Staying away from the cashflow doldrums can simply involve communicating closely with your accounting partner.

Engine Room’s O’Mara says they act as a ‘virtual CFO’ for clients.

“We start by educating the client about financial matters, taking away the jargon and mystique. We don’t expect them to become accountants but they must be able to understand what drives their business and interpret the information and results we present to them.

“We work with them to develop their business plan and the financial outcomes of the plan in the form of financial forecasts. Then we are in regular dialogue presenting evidence to monitor what’s going on. We will help them work through the implications of changes to their business process or focus.

“We basically get under the skin of the business and understand the nitty-gritty of what makes it tick. This close relationship means that we can be blunt about the issues the clients have to deal with,” explains O’Mara.

Engine Room urges good tax saving habits with clients from the outset.

“We have clients who save a percentage of every sale receipt for taxes; others save fixed weekly amounts,” says O’Mara. “It’s critical for a business to have enough and the right financial data to manage the cashflow challenge. First, set profit budgets and cashflow forecasts which identify when the pinch-points for cash occur. Then utilise some good monitoring tools like ‘Spotlight Reporting’ in the form of accurate and timely information about business performance and comparisons to the forecast. Followed by regular re-forecasting as the economic landscape changes.”