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The Financial Tools Businesses Need to Survive in Today’s Enviroment
In today’s environment, it is more important than ever to know where your business is going.
Western Australia, in particular, has been experiencing historical economic growth from our mining boom. But lower commodity prices have started to bite and cause a slowdown in demand. This has been having a flow on effect to those businesses directly involved in mining as well as other support industries.
What we have been seeing is a decrease in demand for goods and services, tightening cash flow and decreasing capital asset values, not only for businesses which directly form part of the mining supply chain but also more broadly for other businesses
Businesses will now operate in a different and more challenging environment compared to two years ago when we had greater economic activity.
It is because of these changing times that we look at our businesses’ finances closely.
• Revenues may be reduced
• Gross profit margins may be decreasing
• Cash flow may be tightening
• Bank finance may be under closer scrutiny
The Day-to-Day Matters
As business managers, it is these changes and the impact on finances that require clear and close monitoring of the financial position of the business. Managers should look at simple, but key financial measures for a business, specifically debtors and creditors.
Debtors – are the lifeblood of most businesses and debtors should be reviewed by management, specifically and the following should be looked at:
• Debtors should be reviewed on a weekly basis;
• Focusing on 80% of the debtor value will mean looking at a smaller number of larger debtors;
• Confirming when are the debtors recoverable and when is the payment expected;
• or if there are bad debts.
Creditors – looking at creditors will not only provide the status of liabilities, but they can also provide a gauge of the cash flow needs of a business or whether a business is trading profitability. To this end, it is worthwhile looking at:
• Are creditors all within due dates?
• What is the timing of when creditors will be due?
• Will the cash flow be sufficient to meet creditors when they are due?
ATO and superannuation – similarly, businesses should monitor its ATO and superannuation position:
• Are ATO payments update to date?
• Can the business meet upcoming ATO payments?
• Are all BAS and other lodgements up to date?
• Is superannuation being met on time?
Management Planning and Reporting
Apart from daily monitoring, management needs to also look at the longer-term outlook for a business; this starts with asking the question where are we now?
This requires looking at the current and historical position of a business, by looking at periodic financial reports for the business on a monthly basis. This requires getting and reviewing the right information and getting the monthly reporting “packs” for the business each and every month. These can include:
• Profit and loss statement for the month and for the financial year to date
• Balance sheets on a month by month basis
• Aged Debtors Listing
• Aged Creditor Listing
Where are we going to – Cash Flow Forecasts
From a business perspective, this really means looking forward and understanding the required financial budget and future forecast, with the most critical measure being cash flow.
That is what is the business’ cash requirement looking forward, what cash does a business need and does the business have enough cash to meet its future commitments.
We often do not see forecasts being used by businesses, but they are valuable tools; and in today’s environment, a critical tool to business survival.
Debt and gearing is an important part of business, as gearing provides the ability to increase investment and grow a business. However, the higher the gearing, the higher the risk.
Importantly, businesses must have a line of credit (such as an overdraft or undrawn facility) to draw upon not only for investment but also for working capital. This is required to cover negative impacts on a business and costs, which may or may not be expected.
So you should be asking–Does your business have adequate lines of credit to fund working capital?
Banks and financiers provide lending on the basis that the borrowings will meet their lending criteria. The agreement with a bank requires not only the payment of interest and principal but also meeting lending covenants such as specified security ratios based on asset values and also specified servicing ratios based on profitability.
If these fall below what has been agreed, then it could mean the loan is in default, which can result in no renewing facilities, or your business being put under watch by the bank, or that the loan is called up, which may result in the bank enforcing its security.
So is your business meeting all of its lending covenants and will you still be able to meet these lending covenants moving forward?
Importance of Early Detection
When the financial position is closely monitored, any problem or future problem can be detected at an early stage. This way, the impending problem such as a cash flow shortfall can be managed. Examples include increasing bank debt, or renegotiation of payment terms with suppliers.
Businesses will often fail, not because of, for example, a downturn in sales, but they will fail because management was not able to see the impact that the downturn in sales would have on the business.
Early detection happens when management has the financial tools to properly monitor the financial position of a business, which I have briefly outlined above.
Businesses will have options to restructure to allow them to continue, but management needs to be able to closely monitor and understand the financial position of the business.
We were asked to look at a manufacturing business which was recently purchased by a syndicate of investors. After the business was purchased, it did not meet the trading which was previously expected and was trading at a substantial loss. The business was on the brink of either closing down and going into some form of Administration or needed a significant turnaround.
We were asked to look at the business. Yes, it was losing money and not trading profitably, but the financial position was monitored very closely and management was able to provide very clear financial reports on the business, including its profitability, profitability by divisions, balance sheet and cash flow.
This provided us with a clear financial map where the business was presently and where it was going. We could clearly see the pressure points such as overdue creditors. Even though it was not trading well, it was clear where it could be taken and we were able to develop and model financial outcomes for the business.
There was also a bank involved who had security over the business and any successful turnaround would require them to support any proposal to effectively keep trading.
After meeting with management, a plan was developed to recapitalise the business via private funding. The bank was supportive and the business creditors were brought up to normal position and a loss making divisions was closed.
The business was turned around and the business has successfully continued trading.
Be aware of the change trading conditions which is now occurring in Western Australia as part of the softening of parts of the mining sector; what impact is this having on your business, or could it still have.
More importantly, ensure that those you or those in charge of managing the business have the financial tools, such as weekly debtors reports and monthly reporting packs. Look at the business’ banking facilities and whether these will meet lending covenants.
Good financial management will give you the road map of where the business is at today and where it is going. It provides you with early detection of impending financial issues. It will help identify the issues to be addressed and will help management find solutions to those issues. In today’s environment, it is a critical part of managing a business.
Article by guest author
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