Where cash is king

The lifeblood of almost any business is cash

The lifeblood of almost any business is cash. It matters little if sales are on target if the money isn't coming in from the debtors, writes Barry McCall

Creditors tend not to be charitable institutions and they are generally unimpressed with excuses about difficulties in getting paid by debtors. Insufficient cash coming in on a regular basis leads to problems in paying regular bills such as wages and suppliers.

Working capital is absolutely vital to almost every business and the availability of adequate working capital is dependent on strong cash flows. In many cases, companies are required to pay their suppliers before they can collect from their debtors, which can quickly exhaust available cash and bank lines of credit.

A lack of adequate working-capital facilities can quickly lead to pressure on bank accounts. This, in turn, means that companies spend an increasing amount of time managing their bank accounts and less on the actual business itself. Furthermore, when the cost of referral item charges, excess interest charges and administration charges are taken into account, as well as the opportunity cost of business foregone, poor cash flows can be very expensive indeed.

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While this may appear blindingly obvious, it is surprising just how many businesses end up in a position of being profitable yet cash poor. Colm Deignan, corporate finance partner with Horwath Bastow Charleton agrees. "It's very common for many businesses to overlook cash flow," he says. "Most companies are profit oriented. They think they are doing fine if they are making a profit and then they forget that the profit can be used up in paying for borrowings and for SMEs working capital is required for growth."

He believes that this is due to many companies having the wrong focus. "Companies tend to focus on budget for profit and loss only and they don't budget for cash flow. Cash is king in my opinion. And many successful small businesses share this way of thinking.

"On the other hand you can find companies with profitable little enterprises running out of cash. Sometimes they get out of the hole with invoice discounting and other products but if they had thought about things beforehand they would be in a far better position."

In other words, companies shouldn't have to use services such as invoice discounting for emergency finance. These products can be excellent sources of working capital which can be used to fund business growth; they shouldn't really be used just to keep a business afloat.

"Working capital is defined as the amount of day-to-day operating liquidity available to a business," says Pat Gallagher, head of strategy and marketing with Bank of Ireland Finance. "When a company is growing, working capital needs are often difficult to determine. New additional sales will almost always create a need for increased liquidity and it is essential that sufficient cash is available to the business at such times. It is also important that a business has an appropriate mix of funding, both in terms of funding type as well as the term of such funding."

Gallagher says that the funding needs of a business differ and will vary within sectors but every business should strive to have an appropriate mix of equity, medium- to long-term debt, as well as both long and short-term working capital. "Short-term working capital can generally be accommodated by way of an overdraft, which is primarily designed to overcome the fluctuations in the working-capital cycle," he says.

"However, some businesses fail to recognise that working-capital needs will grow in line with their sales and this creates a need for longer-term, more continuous working-capital finance. Funding this longer-term working-capital requirement through conventional bank borrowing may not always be appropriate.

Too much medium- to long- term debt may not provide the flexibility an organisation needs, primarily because of its fixed-term nature, while over reliance on short-term funding can put the business at risk," he adds.

Deignan agrees. "Many SMEs do not have financial controllers and this means that they do not have the day to day in-house financial expertise available to them. As a result the focus is on the gross margin. It can be pretty easy to predict overheads in a small business and from that work out gross margin. But you've got to start thinking about cash flow management as well.

"Businesses need more money and working capital as they grow. This means that they have to focus on the gap between paying suppliers and getting paid by customers. This can usually be a couple of months and it is a very expensive gap. When you've got to pay wages every week and so on you can run out of cash very quickly."

He points out that this can lead companies into other difficulties where they hold off on key payments such as those due to the Revenue Commissioners and this can lead to serious trouble down the line. "Companies that are focused on cash flow tend to pay these bills as they fall due and that is the proper way to run the business," says Deignan.

He attributes some of these difficulties to problems in the Irish trading system. "In the UK you will find that the working capital needs of business are much lower due to the fact that debts are paid much more quickly than here," he says.

"In general, invoices are paid within the due 30 or 45 days in the UK, whereas this is somewhat alien to Irish businesses. But this culture is changing slightly, the Prompt Payments Acts for both the public and the private sectors are helping to bring about this change. The level of working capital required by businesses will reduce over time as a result but this doesn't mean that they should focus any less on cash flow. We are still seeing profitable businesses going to the wall as a result of cash flow problems."

"Invoice finance can be the solution to ensuring that an organisation's growth ambitions are not hindered through a lack of cash," says Pat Gallagher. "Invoice finance bridges the gap between the time invoices are raised and the time the business gets paid for those invoices. Under an invoice finance arrangement, invoices are assigned to the bank and businesses can access up to 80 per cent of the value of these invoices, usually within 24 hours.

This ensures that longer-term working-capital needs are funded in line with sales growth and brings a degree of certainty to cash-flow forecasting."

According to Gallagher there are some significant added value benefits to using invoice finance.

These include the fact that the amount of cash that can be drawn is dependent on the value of sales invoiced and is not generally restricted by balance-sheet considerations. It provides a continuous source of cash which allows a business to both enhance its reputation and credit standing with suppliers and take advantage of attractive supplier discounts. It also frees up other tangible security to be used for additional non-working capital business expansion.

"Many businesses fail to adequately plan their business-funding needs and often realise too late that the mix of funding is both inappropriate and inadequate.

"Every growth-oriented company should be thinking about bringing invoice finance into the funding cycle as soon as it becomes evident that they have longer-term working-capital needs," says Pat Gallagher. "After all cash is king, everything else is just an opinion."