A severe shortage of working capital is set to cause a growing number of business failures as companies responding to the recovery become overstretched and insolvent due to a lack of cash. This is the view of a leading restructuring expert from SME specialist accountancy and business services firm Azets, which has offices across the Solent region and throughout the South East.
Working capital is the liquidity available to a business that is not tied up in its daily operations and is a key indicator of the health of a business.
Stephen Grant, a South East-based restructuring partner with Azets, is warning that the economy is reaching the point where a shortage of working capital becomes increasingly common.
He said: “When a recovery is underway and demand from businesses and consumers increases many companies will face a working capital crisis. Entrepreneurs naturally want to pursue opportunities but if cash coming into the business is out of sync with cash leaving the business, the company will be unable to meet its obligations, and quickly face an insolvent position, commonly known as overtrading.”
Stephen Grant added: “Most working capital problems arise when there is a gap between a sale and the collection of the cash. During that time overheads continue, staff and taxes need to be paid, and cash problems escalate. If supplier credit terms are tightened but sales increase, the working capital requirement becomes greater and a business with rising demand can quickly face a cash flow crisis and insolvency. Our economy is moving towards the point where working capital problems will become far more prolific.”
Stephen is urging directors and business owners to take early intervention rather than hope to trade through a working capital problem, a common response which will often escalate the cash flow crisis.
He notes some steps that businesses can take to optimise their financial position.
- Financial Data – Decisions should be based on real time and accurate financial information with investment in quality software, systems and staff.
- Visibility – A 13 week rolling cash flow forecast tracking all receipts, payments and pending costs is a pre-requisite otherwise the business is financially blind.
- Proactive invoicing and collections – A forensic review of all processes that turn orders into cash will identify inefficiencies in cash retention and cash flow.
- Review Inventory Strategy – Match stock to orders and adopt a ‘Just in time’ stockholding policy.
- Stakeholder Relations – A communications plan should be prepared for each group affected by cash flow problems, from customers and investors to staff and suppliers.
- Remove Waste – Waste elimination can be one of the most effective ways to increase profitability in businesses. Studies have found that waste in the way a company operates can be as much as 30% of its operating costs. It is important to undertake a waste audit to fully understand exactly what waste is and where it can be found in processes and procedures.
- Pricing Strategy – Many businesses price their products and services incorrectly. The problem with that is when businesses price too high they miss out on sales and when they price too low they miss out on profit.
- Review of Customers – Carry out a review of profitability by customer and remove those that are not profitable or increase what is charged to those unprofitable customers
Stephen concluded: “Economic recovery is understandably hailed as a welcome respite from economic problems, but it always brings financial challenges for businesses, most notably working capital and cash flow crises.
“Despite the funding and equity options which may be available to businesses, cash as always remains king. Cash is essential to repay debt and finance growth, but a shortage can cause failure and is often a problem that can be prevented with early intervention.”