James Fennessey: Working capital vacuum threat as recovery continues
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, James Fennessey, restructuring partner with Azets in Scotland, has warned.
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.
The economy is reaching the point where a shortage of working capital becomes increasingly common.
When a recovery is underway and demands 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.
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.
Directors and business owners must take early intervention rather than hope to trade through a working capital problem, a common response that will often escalate the cash flow crisis.
Some steps that businesses can take to optimise their financial position include:
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.
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.
In spite of 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.