Does cash flow keep you awake

Posted by Neil Tunstall on 17 March 2014

It is a much quoted reality that cash flow is one of the main things that keeps business owners awake at night. This can be caused by a myriad of issues which may include:

  • Debtors are stretching their payment terms causing pressure on overdraft limits.
  • The combination of growth and increasing Days Sales Outstanding (DSO) putting existing facilities under constant strain.
  • Creditor pressure is placing demand on existing working capital facilities resulting in stop supply or defaults.
  • The inability to take advantage of new markets because all security is utilised to support current “banking facilities”.
  • The realisation that all available security is linked to existing facilities which do not allow the capacity to fully consider succession planning, retirement planning or wealth creation.
  • The impact of ATO obligations on available working capital.
  • Commitment to new Plant and Equipment without fully understanding its impact or necessity.

Does this ring true for your business?
Do these types of issues keep you awake?

I have worked with many small businesses over the years and the above have been the most common stressors that owners face however unfortunately in many cases it is a realisation thatmay come too late in the game.
It is very important that there is a realisation that the old days of simply applying for a temporary increase in an overdraft facility to tide over a short term cash flow issue are long gone. Even the offering of additional security for an increase in facilities can be extremely time consuming in many cases. A far more specific approach aimed at providing the maximum level of cash flow flexibility will greatly assist most businesses
It should also be noted that unless something is done to address the “hard-core” cash flow needs of the business the treadmill will only keep going and keep the business owner awake at night.

I often use the hard-core overdraft in discussions with SMEs as it is a real test of the pressure the company is under. The conversation usually goes something like this:
Thane: Does your business have an overdraft facility?
Client: Yes we have a $500,000 overdraft with our bank
Thane: What is your annual turnover?
Client: $6,000,000 and growing
Thane: How much of your overdraft is hard core?
Client: What do you mean?
Thane: In simple terms what is the lowest point that your overdraft balance reaches?
Client. About $450,000
Thane: So you have a growing business turning over $6,000,000 PA operating on an effective overdraft facility of $50,000?.Without looking any further, I think that you may have an issue with your Suppliers, the ATO or both.

This is a good way to really bring the conversation around to the key issues that need to be fleshed out and what remedies can be used effectively. It also gets the discussion to focus on the client’s complete Working Capital cycle because each component is intricately linked with every other component and should not be looked at in isolation.
For example if the client operates under a secured overdraft basis and is growing the hard core component will in many cases be higher causing issues with suppliers and minimising the opportunity to look at any settlement discount opportunities which may be available in their industry. It also creates issues around credit limits and increases the chance of “stop supply” or defaults which are very dimly viewed by current and potential financial partners and suppliers.
It can also prevent them from using mechanisms such as Trade Finance to source alternative overseas suppliers because the capacity has been used to support their existing overdraft facility.
One of the structures that I believe works extremely well is the use of Debtor Finance as a cash flow tool. A well-structured Debtor Finance facility should take into account the total Working Capital needs of the business as well as addressing issues such as Supplier and ATO pressures.
It can also be effectively used in conjunction with Trade Finance facilities to cover the complete Working Capital cycle by matching the Terms offered under a Trade Finance facility and ensuring that there is sufficient availability when payments become due.(as long as the complete cycle is taken into account.) through a Debtor Finance facility or like
If a Trade Finance facility is already in place then the strategy should be to pay down any extended Trade Finance Bills (which can become Hard Core and severely impact on any seasonality) and ensure that future transactions are properly matched to allow the Trade Finance facility to be paid out from the funding of invoices under the Debtor Finance facility.
In short any Debtor Finance advisor should seek to minimise hard core debt by better utilising the clients available security to move the hard core component to a longer term amortizing facility. This will also ensure that there is sufficient scope available from the proceeds of the Debtor Finance facility to pay down overdue creditors and bring the ATO position back into order.
This is not however a silver bullet and business owners need to be careful that they do not simply opt to pay down overdrafts, creditors and the ATO at the expense of the additional flexibility that they have unlocked. They also need to be both diligent and disciplined with their cash flow management.
It is also very important that the Debtor Finance facility is seen as a Line of Credit secured by their Debtors. As the facility operates in a similar way to an overdraft  there is no value in drawing down every possible cent under the facility as that will only result in unnecessary interest expense. What we encourage clients do is work out what their requirements are going to be for a certain period and draw down sufficient to cover all requirements eg: Creditors, Tax, wages, Lease payments and incidentals. This ensures that there is good discipline with the use of the facility and unnecessary expense is kept to an absolute minimum.
I have also seen a number of examples where the additional flexibility provided by a Debtor Finance facility is used to purchase Property or acquire Plant and Equipment and the like. All of these should be funded through appropriate vehicles such as Property Finance, Commercial Finance or Leasing. When debtor Finance is incorrectly used to fund requirements like this it inevitably creates additional pressure on cash flow when it should be assisting. Using Working Capital facilities to fund longer term requirements is counterproductive and leads to real issues down the track.
Alternatively when mechanisms like Debtor Finance (and Trade Finance) are looked at as a legitimate Working Capital tool which enables a level of flexibility to help  take advantage of opportunities I have worked with many companies who have grown and prospered as a result. The secret is to spend some time and understand the “why” and hopefully sleep soundly.

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