Cash Flow Problems – Regular Working Capital Shortage 2/8

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In the second of a series of eight blogs, our banking experts will look at common cash flow problems that businesses encounter. In this blog, Rick Martignetti discusses a very common type of cash flow problem – regular working capital shortages – which can affect a company’s longer-term investment effectiveness and its ability to meet short-term liabilities.

What causes regular working capital shortages?

When a business has more current liabilities than current assets, it has negative working capital. And when this happens it may struggle to stay afloat during tough economic times or fund growth projects.

A number of factors can make your working capital go negative, including production bottlenecks in manufacturing creating longer delivery times, increases in raw material and labour costs, or if the delivery of goods or services is faster than receipts of revenues. Another common cause is succumbing to pricing pressure from customers or competitors.

If your working capital is negative for an extended period, it usually indicates that your business is struggling to make ends meet. This may force you to rely on borrowing or equity issuances to finance your working capital.

If you do not have adequate cash reserves to weather a short-term cash emergency, or have not planned on how to run your business during such a period, you may struggle to maintain a healthy cashflow in the longer term.

Working capital can serve as an indicator of how a company is operating. When there is too much working capital, more funds are tied up in daily operations, signalling the company is being too conservative with its finances. Conversely, when there is too little working capital, less money is devoted to daily operations—a warning sign that the company is being too aggressive with its finances.

What are the key indicators?

The following financial indicators can help you monitor your working capital, enabling you to spot warning signs and prevent any long-term damage to your business:

  • Limited cash availability or evidence of habitual overdraft borrowing.
  • Increasing debtor days or reducing creditor days.
  • Heightened levels of stock and work in progress (WIP).

When faced with a regular working capital shortage, these are the steps that key stakeholders within your business should take:

Role of the MD/CEO

The MD/CEO needs to take control of the emerging situation by:

  • Holding emergency Board meetings to review likely causes.
  • Reviewing existing KPIs to evaluate appropriateness.
  • Revisiting business funding lines and assessing whether these remain fit for purpose.

Role of the FD

The FD needs to take responsibility for identifying internal and external solutions to mitigate the short-term deficiency in cash flow by:

  • Reviewing pricing policy and adjusting where appropriate.
  • Tracking collection time with customers to identify which are slow payers.
  • Negotiating better creditor terms and focusing on timely debt collection.
  • Reviewing stock levels and production efficiencies.
  • Considering options such as seeking an increased overdraft, recapitalising the business and shareholder support or leasing.

Role of Ops/Sales

The Sales and Operations teams need to support the MD and FD by:

  • Assisting the MD/FD in reviewing and addressing the above issues.
  • Reporting on pricing policy and the capacity for the market to accept price/rate increases.
  • Ensuring the production process is running as efficiently as possible.

Key points

It is really important to review your existing funding lines to see if they are still relevant. For example, have you utilised working capital lines for capex or investment purposes? Consider how funding lines can be reorganised to create sufficient headroom and conduct cashflow modelling to determine the long-term working capital needs of your business.

I hope this blog has provided some useful tips on what may trigger a regular working capital shortage and how your teams should work together to mitigate any long-term damage. If your business is facing a similar cash flow situation, please do feel free to contact me, I’d be delighted to help.

Rick Martignetti – Associate, Shaw & Co

Rick is an entrepreneurially focused corporate finance expert with a passion to help businesses to manage risk. Over the last 20 years, he has advised on debt hedging instruments over £3bn+ in client debt portfolios and arranged over £5bn+ in client foreign currency hedging transactions. He has held senior roles at Royal Bank of Scotland, National Australia Bank and Lloyds Financial Markets. At Shaw & Co, he advises clients in a range of sectors including Hospitality, Energy & Renewables, Engineering, FMCH, Healthcare, Human Capital, Leisure & Manufacturing.