Cash Flow Problems – Short Term Capital To Fund Growth 5/8

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In the fifth of a series of eight blogs, our banking experts are looking at common cash flow problems that businesses encounter. In this blog, Rick Martignetti discusses what can happen when short-term capital is used to fund growth.

What causes this type of problem?

A lack of cash or financial expertise could see you using short-term facilities – such as an overdraft – to fund your long-term growth. This is a habit you need to break, because this approach is fraught with risk and typically indicates poor financial management or a lack of assets to support long-term debt financing.

Businesses that are over-trading typically fund growth by using short-term capital such as overdrafts which often have low credit limits, further constraining growth. The key point is that you need to choose the right form of capital to power that growth.

What are the key indicators?

The following financial indicators can help you identify if your business is using short-term capital to fund long-term growth:

  • Regular overdraft usage and/or lack of cash.
  • Rising trade creditors or increasing creditor days.
  • Over reliance on factoring, that is, using invoice discounting facilities as opposed to long term debt, or the absence of structured finance in the balance sheet.
  • Deferring supplier payments and increasing creditor days.
  • Late debtor receipts and not managing debtor days.
  • Growth in overheads, particularly increasing fixed overheads which are difficult to manage in a downturn.

When faced with these indicators, these are the steps that key stakeholders within your business should take:

Role of the MD/CEO

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

  • Understanding the risks of funding long-term growth as opposed to using short-term facilities.
  • Forming banking relationships which are supportive of the business over the long term.
  • Considering more than one provider of finance through, for example, multi-banking and securing finance from different sources to mitigate risk.

Role of the FD

The FD needs to take responsibility for identifying internal and external solutions to protect cash flow by:

  • Providing detailed forecasts of trading activity and accurate assessment of the order pipeline.
  • Working with Sales/Ops to understand the macro-environment and flexing the forecasts based on different trading scenarios.
  • Negotiating better creditor terms and focusing on timely debtor collection.
  • Regularly reviewing bank and alternative funding solutions.
  • Managing stock levels and ensuring the efficiency of stock control.
  • Constantly reviewing the pricing policies.

Role of Ops/Sales

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

  • Reinforcing contractual terms with clients and regularly communicating with finance to optimise cash collection such as milestone payments.
  • Ensuring that the business has sufficient working capital facilities before entering into new contracts.
  • Bringing invoicing forward on milestone payments to assist working capital pressures.
  • Communicating with the FD on any production issues, pricing and capacity.
  • Ensuring that there are no manufacturing or production bottlenecks which might hamper sales by preventing finished products being delivered at the right time.
  • Making sure that the sales proposition remains relevant and competitive in the market and adjusting if required.

I often see owner-managers using overdrafts or short-term funding to fund long-term projects or having just one provider for their financing needs. This is a risky game to play especially if you consider the consequences of the finance partner going out of business or lack lending appetite.

Unfortunately, many SMEs lack enough experience in funding decisions to make the right financing decisions. My advice to any owner-manager is to form relationships with multiple financing sources that are supportive of your business and its goals. This approach will help you mitigate risk to ensure the long-term viability of the business you have grown.

Key points

Here are my key points to keep in mind to avoid the pitfalls of this type of cash flow problem:

  • Always ensure that there is an appropriate balance between long and short-term funding to support your business and its growth.
  • Validate what security, such as personal guarantees, your business is prepared to provide to obtain facilities.
  • Minimise any financing costs.
  • Ensure that your business is not over leveraged and manage your balance sheet to prevent a lack of capital that could put pressure on your business and its growth ambitions.

I hope this blog has provided some useful tips on what may trigger a cash flow problem caused when short-term capital is used to fund growth 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.