It’s no secret if you are an SMB in Australia right now: capital is scarce, with no sign of improvement on the short-term horizon. Raising traditional bank debt to finance business growth, acquisitions or succession planning has become incredibly challenging.
Even some of the more risk-taking, high net worth investors are becoming so cautious that it’s difficult to get them to invest in very worthy SMBs.
Before this sounds too doom and gloom, it’s important for SMBs to know there is a capital strategy they can be using to position their business well for the upswing that will (eventually) come. It may not be the sexiest of the capital strategies, but it’s important not to disregard the often forgotten and least expensive type of capital: your very own working capital.
Businesses that survive a recession are those who’ve kept a close eye on working capital. They are considerably more robust and consequently more valuable when the economic pendulum swings back to “good times”. It’s because these businesses, to survive, have had to really understand their cost base and product lines, and work extremely hard to get working capital (read: cashflow) under control.
In tough times, good businesses will need to have a much stronger management team in place. A CEO, board or individual business owner rarely looks as seriously at the underlying performance of the business and its management when the good times are rolling. They just don’t want to change anything for fear of losing what they have and are enjoying – profit!
Understanding your business, clarifying your costs and assessing the overheads it takes to deliver such profitability is an extremely worthwhile use of your time in “hard times”. It’s certainly a better and less risky option than to just struggle on, waiting for something in the economic or business horizon to change.
How to manage working capital
Running a business in this market has to become a science not just a reliance on gut feel or ill-founded assumptions. The better you comprehend the numbers, the better your decision-making will be.
Management of working capital drives savings in interest expense, so why is this seemingly less attended to? It’s mostly because humans enjoy repetition of the same practices and processes: so whatever process we designed in the beginning will, by and large, be repeated to the end.
After someone has been running a business for a couple of years, they can have a blind spot to loss-making products or aged inventory. Likewise, new employees may not want to rock the boat too much so they repeat practices of the past, right or wrong.
In the current tough economy nearly all sectors seem to be experiencing, we can really hone in on our cost base, look at which products or services makes us a dollar and concentrate on those.
1. Keep it simple
Keeping the business laser-like in its focus, with careful planning and execution, allows you to grow and retain earnings, pay down debt (and the tax man) and sleep at night.
When better economic times reappear, your track record of adjusting your business (taking considered and deliberate steps to making regular and rising profits) will make banks and other, new potential shareholders more willing to give you expansion capital.
So be patient and do the simple stuff consistently: if this is not exciting enough for you as a business owner, employ someone else to do it and stand back from the business and watch as it grows.
The banks will lend but only when all of the boxes are ticked and the first box is whether your tax debt is being managed, even if you are under a repayment program – it has to keep being met, not just for the first few months.
2. Know how much cash is tied up in your stock
One of the main issues is that business owners usually see costs as total costs, and rarely drill down by product to find out exactly which products are delivering true gross margin to their business. As simple as it sounds, if the market can take more of a higher gross margin product over another product then stock up and deliver additional sales on that particular line.
Concentrating on a smaller range of fast-moving stock lines will lead to greater profitability, lower working capital requirements, perhaps even a lower unit cost (after negotiating a lower unit price) with an improved bottom line. All this helps generate the number one aim of every business – cashflow.
A client we recently worked with was a fast-growth business which found that 75 percent of its inventory turned less than twice per year. As a consequence the business needed a bank facility to manage the cash shortfall.
We helped them to identify slow-moving products, which they are now selling off. This meant the bank facility could be erased as they are banking more cash, even if the margin on the aged stock has been reduced.
By the way, when you talk to stakeholders, don’t just talk in terms of gross margin. Add in stock turns on a per product basis – that will tell a knowing bank manager or shareholder you understand your business and which products turn into cash.
3. Get your monthly accounting in order
Prepare monthly accounts and see what the trends are. Then break down your revenue line into revenue per product and from there into each product’s gross margin.
Your accounting systems need to be set up so that you can easily see the true gross margin (and its relative contribution) of each product.
Product costing systems are relatively sophisticated accounting systems which determine your product’s individual cost. If these systems are beyond your budget, I would advise SMBs to mathematically work out how much raw material A, B & C is required for each product. Then work out a per unit total cost, how much time it takes to make. The next step is to work out your labour cost per minute: average hourly rate plus 30 percent for on costs, and add costs for your overheads (which could be as much as 40 percent of the total cost of labour and raw materials).
So be patient: these tough times may be a good opportunity to give a real “cold eyes” review of your business. Then, once you have it under control and you understand the levers to pull to generate cash, you have a very attractive proposition for any bank, shareholder or merger partner.
One thing a new investor is particularly looking for is consistent performance post investment, so they would expect ever-increasing profits and cash.
Once you understand your working capital drivers – that is, how to generate cash – and can demonstrate that to a potential investor, you will have them banging down your door. Possibly sooner than you would think.