Cash Flow Problems – Inappropriate Capital Structure 6/8

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In the sixth of a series of eight blogs, our banking experts are looking at common cash flow problems that businesses encounter. In this blog, Alexei Garan discusses what can happen when the wrong methods are used to fund your business.

Using the wrong capitalisation structure can severely impede your operations and stifle growth ambitions. Capital structure is the proportion of debt and equity used by a company to finance its operations and growth. It includes short-term debt, long-term debt and common stock.

Debt consists of borrowed money that is paid back to the lender (typically with interest), whereas equity consists of ownership rights in the company, without the need to pay back any investment.

When financing any growth project, it is important to use the appropriate funding facility. Having an imbalanced capital structure could lead to the business struggling to make debt repayments, accessing capital investment, or not yielding the required equity expected by shareholders.

What are the key indicators?

The following financial indicators can help you identify if your business has an inappropriate capital structure, allowing you to spot warning signs and prevent any long-term damage:

  • Debt/equity imbalance (excessive gearing) creating unforeseen creditor and counterparty issues.
  • An increase in retained losses.
  • Excessive dividend extraction which is depleting reserves.
  • Unrecognised revaluation reserves.
  • Insufficient cashflow generation to service debt, resulting in covenant breaches.

When faced with an inappropriate capital structure, 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:

  • Reviewing with the FD the current balance sheet to identify key structural issues.
  • Assessing existing funding documentation to establish your options and understand the penalties which a lender might impose.
  • Identifying whether there is scope to improve cash collection. For example, has there been a change in creditor payment terms or lax debtor control?
  • Evaluating dividend levels and their appropriateness in current circumstances.

Role of the FD

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

  • Assisting the MD with data gathering and root cause analysis.
  • Reassessing current cash flow to see if there is scope for improvement.
  • Identifying whether there are any undervalued assets which could improve reserves.
  • Preparing a summary of all financial instruments for internal review and to fully understand what risks the business is likely to face.

Role of Ops/Sales

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

  • Expediting delivery of long-term projects to minimise cash flow pressure.
  • Maintaining strong sales and marketing efforts to drive demand for products or services to boost revenue.

Key points

In summary, try and consider whether this is a short-term issue or a fundamental balance sheet problem that needs to be resolved. Also consider how to approach affected parties and the basis on which their support should be sought. It is worth reviewing whether there is scope to restructure your debt stack to reduce reliance on cash generation. And always consider equity raising options.

I hope this blog has provided some useful tips on what may trigger cash flow problems caused when inappropriate capital structures are used and how your teams should work together to mitigate any long-term damage. To see how we recently helped Ensilica UK overcome a similar situation, please read our case study here.

If your business is facing a similar cash flow situation, please do feel free to contact me, I’d be delighted to help.

Alexei Garan – Head of Debt Advisory, Shaw & Co

Alexei leads Shaw & Co’s Debt Advisory team and supports clients in a range of sectors including Energy & Renewables, Engineering, FMCG, Healthcare, Human Capital, Leisure, Manufacturing and TMT. Over the last 10 years, he has advised on over £2bn in restructured post crisis client portfolios and arranged over £400m in client funding. Alexei has also been called in as an expert witness in several post-financial crisis legal cases.