Finance is the lifeblood of every business, whether it is short-term working capital requirements or longer-term bond issues to fund business growth, every company needs access to finance if it is to succeed.
In the immediate short term or working capital requirements, businesses are coming up against a combination of inflation, economic uncertainty, exchange-rate volatility and supply-chain disruption, which is leading to concerns. For example, because of continued disruption in supply chains and shortages of some materials, more and more businesses are changing from a ‘just-in-time’ to a ‘just-in-case’ approach to purchasing, resulting in a stockpiling effect. This investment in additional inventory is leading to additional working capital requirements which may need to be funded by borrowings.
Damien Hunt is working capital lead for PwC Corporate Finance. He knows that businesses have an absolute need to invest in the growth of their business and cannot do so without adequate levels of working capital being available.
“Entry into new markets or availing of growth opportunities can only be achieved with the availability of working capital. However, growth should always be at a manageable and sustainable level to avoid an overtrading scenario,” he says.
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“Interest rates are increasing, and additional working capital will come at a higher cost. Banks and finance providers are also becoming more selective in extending credit. Often businesses look to expensive “quick fixes” to meet working capital requirements, which may not be suitable to each individual business’s profile. Better management of payables, receivables and inventory will result in the release of cash which can then be utilised to fund additional working capital requirements without any cost of funding,” says Hunt.
Ciaran McAreavey is the managing director of Close Brothers, Ireland, and he has also witnessed the change from ‘just-in-time’ to ‘just-in-case’ operations which pushes up inventory levels.
“This is being exacerbated by their own customers taking longer to pay. All of this results in more of the business’s capital being tied up in working capital assets [ie, increased debtors and inventory without the corresponding offset of increased creditor finance]. Many businesses find themselves asset rich but cash poor, resulting in liquidity challenges even if the business is trading profitably,” says McAreavey.
Peter Bennett, Davy’s head of investment technology banking, emphasises that where short-term financing is needed it is vital to match the financing needs with comparable short-term finance. As a rule of thumb, Bennet categorises short-term requirements as about one year and long-term financing coming in at five years.
“The amount a company can borrow is typically related to the size of the cash flows. It’s similar to obtaining a mortgage where the amount borrowed is matched by income. Businesses can try any number of lenders from traditional banks to specialist lenders,” says Bennett.
As an adviser, Hunt advocates for better credit functions to release working capital. Faster collection of customer invoices will boost the cash position he says.
“But this is just one piece of the cash conversion cycle. There are other ‘quick wins’ available to free up cash. Companies should reassess invoicing processes in order to eliminate any inefficiencies that may be causing delays in sending invoices to their customers. These inefficiencies can include manual processing, lost invoices, and a high volume of invoices to manage. Small process improvements can have a big impact on a business’s working capital,” says Hunt.
“In the longer term, businesses must also develop a cash culture across the entire organisation — an environment where collecting receivables, minimising inventory days and improving working capital performance as a whole is not regarded solely as the remit of the finance function but as part of everybody’s role. To do this requires tighter management focus and more discipline around processes such as payables management and more stringently managing their supply chain.”
Another popular method of finding short-term finance, according to McAreavey, is invoice finance. Typically, this allows a business access up to 90 per cent of the value of unpaid invoices (debtors). Unlike a traditional overdraft this type of funding grows in line with turnover, which can increase due to the impact of inflation on selling prices as well as increased activity. Invoice finance suits most businesses which sell goods or services on credit terms.
“Our asset-based lending products further extend invoice finance with funds released against other business assets such as plant and machinery, inventory and property. We can also provide top-up cash-flow loans,” says McAreavey.
For longer term financing, Bennet suggests companies need to get their house in order first.
“It can be complicated and time consuming to arrange longer-term financing. There are a variety of solutions available, both domestically and internationally. Having an external expert to guide your journey can be very helpful.”
McAreavey cautions matching relevant debt vehicles to each individual business.
“The appropriateness of each is unique to the business, depending on factors such as the security it can offer, the level of repayments it can afford and the volatility of its cash flow,” he says.
“A loan tends to be a medium- to long-term commitment and before taking out a loan a business should be satisfied that it can meet the conditions and repayments of the loan even if the business meets unexpected challenges.”
Another important point raised by Bennet is for the business to know how the proceeds will be spent.
“You’d be surprised by the number of companies that don’t really know how they will spend the money once raised. I would advise they know the use of proceeds intimately.
“And to add into that mix the cost of money is becoming more expensive with the increase in interest rates. One of the biggest challenges in the market right now is the visibility of the cost of credit over the short, medium and long term. With inflation going up it makes the process of finding credit even more daunting. Definitely figure out what you are going to spend the money on — and get help,” concludes Bennett.