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Riding the Storm
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Secantor November 2008 Newsletter
The banking system has been under substantial pressure over the past few months, but hopefully the corner has now turned and we are entering a more stable period with lower base rates which will allow the money markets to begin to operate, albeit at higher lending margins.
However, for many businesses this looks like the beginning of a potentially very difficult period. There is more evidence that the UK is in recession. Many business owners have not had to deal with such tough times before and are going to have to think carefully and take appropriate measures to weather the storm ahead. This article looks at some of the actions businesses should be taking now to maximise their chances of survival.
Information
To manage a business properly, information is needed and it needs to be accurate and timely. Management information takes many guises and it is important that the information is relevant and tailored to that business.
Forward looking information is probably more important than historical information in riding the storm. The most relevant sources are likely to be:
• Forward order book and/or sales prospects. This needs to be looked at frequently and action taken where necessary. What can be done to promote more orders? Can volume discounts be introduced, special offers etc? Are cuts in the workforce required, or reduced working? Can overtime be reduced?
• An integrated 12 month forecast including detailed P&L, balance sheet and cashflow. This will give the business a view of what the next 12 months looks like and how much cash it needs. It should be produced on a likely scenario basis together with some sensitivities to look at the cash implications if these occurred eg if sales fall or increase. The forecast should be compared to what actually happens on a month by month basis, identifying what caused the variances and should be revised as necessary.
• 13 week rolling cash forecast. This should be very detailed. It will give a view of short term cash requirements and can act as a tool for managing cash on a daily basis. This is essential if the business is tight for cash.
Historical information does play a part in managing the business. It enables the business to assess how it has performed in the past, and what has and hasn’t worked. Often though, it requires detailed information and analysis to enable conclusions to be drawn and corrective action to be taken. For example:
• Analysing profitability by individual product lines, sales channels, customers or types of business. This often produces many surprises but can help the business identify areas where effort and resources are being used ineffectively and help make decisions to eliminate or turn them around.
• Looking at individual cost lines to reduce overheads
•Key Performance Indicators (KPIs) can be extremely helpful in managing a business. In a straight forward training business for example, a KPI is often the number of training days sold or the number of people trained in a month.
Actions
Urgently review the information below. Some of the points are general housekeeping but in a recession it will be the tidy businesses that survive.
Sales
Where a business has many product lines, it is important to understand the profitability of each line. Some businesses find when they do this exercise that salesmen are actively selling the loss making or poor profit ranges and neglecting the most profitable. Understanding the margin on each item allows the company to consider whether to keep the product as a loss leader, increase its price or stop supplying it all together. Thought also needs to be given to the resources (human, cash, effort) involved in generating sales of various types, so that effort is concentrated where most volume, profit and cash can be produced.
It may also be worth reviewing sales and marketing methods and consider targeting customers who have not recently bought with special offers or other inducements, though make sure the sales are profitable and introduce quantity discounts or early payment discounts. Make sure credit limits are in place for customers and stick to them. Review all old ones as well.
Costs
Reviewing staffing levels is essential; don’t carry any unnecessary baggage in this area. Take into account though that redundancies could cost the business cash in the short term.
Look at purchasing policies and consider renegotiating with suppliers (biggest ones first!) or seeking new tenders. Look at payment terms as part of such an exercise - they can easily get missed.
Balance Sheet
Balance Sheets are fundamental in any review process. Working capital is probably the first place to start. It is made up of three elements (debtors and stock, less creditors) and represents the amount of cash tied up in the actual trading of the business. Minimising working capital also reduces cash tied up in the business.
Stock
The reduction of stock usually requires a detailed exercise to be carried out. Some points to consider:
• Can stock levels be reduced in particular areas? Check stock turn.
• Can obsolete stock be sold or used, perhaps by heavy discounting? Selling obsolete stock may generate a book loss, but this is only accounting recognition of the fact that it’s not worth much. It is probably much more important to release the cash tied up in it.
• Can the product range be rationalised?
Debtors
Collecting cash is important for any business and the objective of a sale is not achieved until the cash is in the bank. Businesses need to understand what is causing delays in debtor collection.
• Are payment terms properly negotiated with customers, and enforced?
• Are inaccurate invoices a problem, giving customers an excuse not to pay?
• Does the timing of issue of invoices mean that they miss a customer payment run?
• Is the credit control function effective and well-managed?
• Beware customers who have not used you for a while. It could be they can’t get credit from their usual supplier.
• Are customers telephoned before a payment is due to check it has been scheduled and to allow any problems to be resolved?
• Are any retentions being collected?
Creditors
The final element of working capital to consider is creditors. It is important to remember that the liability for a purchase usually arises when the order is placed and so procedures may need to be reviewed to ensure control is exercised over all orders.
Creditors need to be kept happy enough to ensure continuity and reliability of supply – but no more than that!
• Ensure that favourable payment terms are a central part of negotiations with suppliers.
• On large sales contracts, try to align payment terms to suppliers with those from the customer.
• Ensure invoices are thoroughly checked.
• Try to establish a routine for payment of major suppliers so they are paid consistently – just as your customers pay you!
Remember that supplier payments are a difficult part of a cash flow forecast – you can delay some payments to help you through a tough spell, but you will have to catch up later and that will hit cash.
Cash and funding
Above all, remember that ‘Cash is King’ and that liquidity is essential for survival (just as has recently been the case for banks!). Concentrate on cash generation and retention before profitability – the establishment of a good cash reserve, and properly agreed loan facilities where necessary, will enable many a storm to be weathered and give you time to resolve problems. If you are short of cash, or dependent on an overdraft which can be withdrawn, then a relatively small and temporary trading difficulty can quickly become much more threatening.
Review your funding position as a matter of urgency. Put term loans in place where they are more appropriate than overdrafts (i.e. where borrowing is long-term rather than for temporary fluctuations). Consider bringing in new equity if you have confidence in the business – now is not a good time to be highly-geared. Remember that it will be almost impossible, in the current climate, to raise funds externally when you’re in trouble, however temporary.
Finally
The above actions are an indication of some of the things a business should consider. The specifics will depend on the business and how it operates and in what sector. To maximise cash and profits in a recession requires a good understanding of the business and how it works. This takes time and resource but the results can be significant. Secantor provide experienced FDs to work with companies on a project basis to assist with such exercises.