Cash Flow is King
Cash Flow is King
Cash Flow Management Education - helping businesses succeed and grow
Don’t get me wrong, profit is important. It is why people go into business, however, it’s also important to understand that profitable businesses can and do go broke!
We have all seen recent examples of business failures. Almost weekly, the media report of yet another high profile business closure. Some of these businesses are sold however a large number just disappear, leaving employees, suppliers, customers and owners out of pocket. All too often we see examples of business owners not considering or understanding the financial consequences of their actions. Financial decisions can and do have long term consequences and lessons which we can all learn from.
Don’t pay too much for the business
Before buying a business it’s critical to understand what the business is really worth. Purchasers should seek experienced independent advice to support their assessment. Just because the vendor is asking a given price doesn’t mean the business is worth that amount. Undertaking a due-diligence study is critical.
Take into account the business’s future maintainable earnings, lease terms, term of the franchise agreement, condition of plant/equipment, condition of fixtures/fittings and future refurbishment requirements (cost, timing and impact to the business). Also consider the life cycle of the product or service to be sold.
The amount paid for the business together with ingoing costs, working capital etc. will impact funding costs and loan repayments. Your accountant and lawyer will be able to assist.
Don’t spend the depreciation
Most business returns are quoted on a earnings before interest, tax, depreciation and amortisation basis (EBITDA). Take time to understand what this means. Depreciation is a non-cash expense charged against the business profit. It is used to reflect the ongoing use and declining value of plant, equipment, fixtures and fittings etc. In time these items will need to be replaced.
Most franchisors have specified refurbishment and replacement guidelines. To fund these replacements, business owners should apply the depreciation values to either additional debt repayments (to provide a capacity to re-borrow to replace the assets) or set up a separate bank account (known as a sinking fund) to set aside funds to meet these costs. All too often business owners see the depreciation as a never ending cash resource which is often directed towards non business related expenditure. Examples include using the depreciation value to repay a loan for an upgraded house or luxury car, neither of which add anything to the productive capacity of the business.
Consider the future
Business owners need to keep a close eye on the business environment on both a local and national basis. Interest rates may increase, unemployment levels may change, and costs will increase. Understanding how these will impact their business will assist owners plan for the future.
Reviewing budgets and undertaking some sensitivity analysis will also assist. This means looking at cash flow budgets and plugging in different assumptions to reflect what could happen in the future. As an example, what would the impact be if interest rates increased by 2 per cent, or what would happen if a supplier closed and goods had to be sourced from a more expensive provider?
Understand the financial statements
Business owners must take time to have a detailed look at their financial reports. Learning how to analyse profit and loss statements and balance sheets is time well spent. Undertaking regular analysis with the assistance of business advisors should be a normal part of the business planning process. Understanding key success factors and how to calculate a break-even point are valuable business tools. Without this business owners are flying blind. The local TAFE or websites like Westpac’s Davidson Institute (www.davidsoninstitute.edu.au) are ideal starting points.
Plan for the good times as well as the bad
Economic times continually change and it may be a surprise to hear that business failure rates in strong economic times are almost as high as those in tough times. In good times business owners can make decisions that restrict the business as conditions deteriorate. Lease costs that are too high, excessive reliance of a small number of customers, commitment of cash flow to non-business related purposes are some examples. Keeping a close eye on business results and not being afraid to react quickly can reduce any negative impacts. For example, the reason for a drop in turnover needs to be quickly understood and the business expenses adjusted accordingly. Staff hours may need to be reduced, labour mix changed or the business owner may need to spend additional time working in the business.
Seasonality and other issues impacting cash flow
It is rare to see a business which is not impacted by some level of seasonality or other distortions which impact a steady cash flow. Taxes (GST, Income, PAYG etc.) need to be paid, equipment replaced, stock ordered and paid for. All of these factors need to be considered in the businesses cash flow cycle. The slower the cash cycle, the higher the working capital requirement.
Expect the unexpected! What if the local council decided to upgrade a road or temporarily restrict street access? What about weather events, long term power outages etc.? It is always prudent to have some financial resources in reserve.
This reserve should be in addition to the normal working capital allowances. A recent example of an unexpected event was a business owner who on day of settlement had their roof cave-in due to excessive rain. The business was closed for over a fortnight and while there was some insurance coverage in place, it took several months for the owner to get paid. Meanwhile, they had to meet their overhead costs, wages and loan repayments.
These stories are not isolated and have a significant and immediate impact to business cash flow
Don’t be afraid to ask for help
Business owners who find themselves with cash flow problems should ask for help early. The earlier any issues are detected, the greater the options that will be available. Engaging with the franchisor and establishing a time bound and measurable action plan is a starting point. This plan will examine and monitor outcomes closely adjusting actions as required. Involving advisors such as accountants, lawyers and bankers will ensure all understand what the business needs to do to get back on track.
This action may include the business owner selling personal assets to return capital to the business. Owners are best advised to take charge of the situation and make the hard decisions early.
It’s not all doom and gloom
Taking the above into account, being a business owner can be one of the most rewarding things people will ever do. This is reflected in the large number of Australians that continue to aspire to become business owners.
Additional free information is available at Westpac’s Davidson Institute, visit www.davidsoninstitute.edu.au.
Steve Seddon is Westpac’s, Senior Business Development Manager – Franchising, Western Australia, Queensland and South Australia. He is a CPA and a member of the Franchise Council of Australia’s Western Australian committee.
Westpac continues a long-term commitment to the franchise sector in Australia. The bank has a national network of franchise specialist business bankers who are able to deal with the specific needs of the franchise sector.
Contact Steve at:
The information contained in this article is intended as a guide only and is not intended as an exhaustive list of matters to be considered. Persons entering into franchise agreements should seek their own independent legal, accounting and other advice.