One of the reasons businesses run out of cash – and generally go broke – is that they grow too fast. What a paradox – the business is growing too quickly and is therefore too successful for its own good! Not surprisingly, in situations like these you also find that the largest “creditor” of the business has been the Australian Taxation Office, due to either unpaid tax liabilities. In other words, the business has used the ATO as a banker. The obvious question is – why? The broader answer is very simple – lack of access to alternative funders. Debtor financing or debtor funding is one of the options that is generally not explored – but could be a reasonable solution.

What Are The Funding Sources For A Growing Family Business?

A typical family-owned business usually only has two main sources of funding – the owners or the bank – and the latter option is generally only available if the owners have “bricks and mortar” security (i.e. their home).

Where the business owner has little or no equity in their home and/or the funding needs of the business exceeds the amount they can borrow against their home, the options tend to be very limited. Banks may still lend something against the assets of the business (e.g. stock and debtors), but the size of this facility is often a fraction of the assets pledged as security and the facility may not increase as the cash flow needs of the business increase.

Children taking over a business from their parents may also lack the amount of capital (or property security) needed to grow the business.

Family-owned businesses are also reluctant to call in a “white knight” (a friend with cash) or venture capital provider. In any case, the latter are generally not attracted to smaller “mum and dad” family businesses. This therefore only leaves two sources of funding – business creditors and the ATO. Business creditors tend to get looked after as the business owner wants to ensure supply of raw materials to their business, which just leaves the ATO. However, you ought to be aware of recent changes made by the ATO in relation to tax debt interest charges.

One often overlooked source of funding may be to “borrow” against the debtors of the business through a debtor finance arrangement (previously called factoring).

How does debtor financing work?

Traditionally thought of as a lender of last resort, debtor finance companies should not be overlooked as a source of funding for growing businesses, provided the business is profitable. The latter point is crucial, because it is no use accessing cash flow (from anywhere) if the business is not making money. The cash will soon run out and the business will go broke. This was also another reason provided in one of our previous articles about why businesses don’t have cash – they don’t have a cash flow problem, they have a profitability problem. A lack of cash is the symptom, but a lack of profitability is the cause.

Assuming the business is profitable and growing, debtor finance provides an opportunity to borrow against the debtor book, particularly where it is a high quality debtor book. Generally, debtor financing companies will advance a percentage of the debtor book (e.g. 75% or 80%) for those debtors who have been outstanding for less than 90 days.

Benefits of Debtor Financing

Debtor financing offers a wealth of advantages for growing businesses:

1. Improved Cash Flow

Free up cash tied up in outstanding invoices—typically between 70–90% of the invoice value is released upon submission—enabling you to cover wages, supplier costs, or invest in opportunities without waiting for payment terms to end.

2. Growth on Your Terms

As your sales increase, so does your finance limit – making debtor funding more flexible than traditional loans constrained by physical collateral.

3. No Real Estate Security

You’re not required to pledge property. Instead, lenders use your invoices as security, making debtor finance ideal for entrepreneurs without bricks-and-mortar assets.

4. Efficient Credit Control

With invoice factoring, your finance partner often handles debtor collections—leaving you to focus on core business activities.

5. Predictable Funding

Access to funds aligns with invoice generation, and repayments occur only when customers pay. It’s a financing model that adapts seamlessly to your business’s rhythm.

6. Accessible for SMEs

Often quicker to arrange than traditional bank loans, debtor finance is well-suited to companies without extensive asset backing or high turnover.

Different Types of Debtor Finance

Understanding the main forms of debtor funding helps you choose what best fits your operation:

1. Invoice Factoring (Disclosed)

• You sell your invoices to a finance provider.

• The provider collects payment directly from your customers.

• Common advance rates range from 70% to 95%, typically with higher fees due to the additional credit control service

• Ideal for small or mid-sized businesses that prefer not to chase payments themselves

2. Invoice Discounting (Confidential)

• You borrow against your invoices while retaining control over collections.

• Customers remain unaware of the arrangement.

• Advance rates typically sit around 80–85%, with lower fees than factoring

• Suited for larger businesses with in-house credit teams

3. Full‑Ledger vs Partial‑Ledger Facilities

• Full‑ledger: finance provider supports the entire receivables ledger.

• Partial‑ledger: you select which invoices to finance (even on single‑invoice basis)

• Full‑ledger offers simplicity; partial provides more flexibility and control.

So, why don’t more family-owned businesses take up debtor financing?

There are a probably number of reasons for this. One reason might be the perceived stigma. Often, debtor financing companies will require that the arrangement be disclosed to the customers of the business and collection of the outstanding debts is handled by the debtor finance company. Whilst this needs to be carefully managed, there could be a “good news story” in here for the business and that story should be “sold”. The business is growing! Every business owner understands that a growing business needs to fund cash. So should your customers.

Secondly, the business is “outsourcing” its debtor management, thereby enabling the owners to focus on doing what they do best – build the business. You may also find that your debtors are better managed (and more likely to pay on time) when there is greater focus applied.

Another reason may be because debtor finance is generally a more expensive form of funding than traditional bank finance secured by a property. This is not surprising – it’s more risky. If the business owner had property to put up as security then they wouldn’t need debtor finance. So it is important to understand what the cost of funds will be. Even if the effective cost of funds is (say) 15%, provided the business is making a return on capital employed (ROCE) of greater than this then they are in front. In other words, if the ROCE for the business is, say, 25% then the business owner is still in front by 10% once the financing cost has been paid. Would you rather make 10% of something or 100% of nothing?

Clearly, in a perfect world having access to an unlimited supply of cash is utopia. However, we don’t live in a perfect world and business owners frequently have to deal with imperfection. The challenge for business owners using any sort of funding, but particularly debtor funding is to know the key financial parameters of their business.

The big three financial ratios every business needs to know

1. Know your ROCE. If you don’t know this and the areas of your business that drive it, you’re driving blind.
2. Know your free cash flow (FCF). Work out your after-tax profit. Subtract from this the amount by which the capital employed in the business has grown during the year (or last year). If the answer is negative, you have negative FCF and this can’t be sustained forever.
3. Know your Working Capital Absorption Ratio. This is simply the amount of additional working capital your business will need to fund a given increase in sales. This can vary significantly from business to business. If you don’t know this and you have a growing business, you’re in risky territory, unless of course you have an endless supply of cash.

At MGI South Queensland our specialist business growth advisors in Brisbane and on the Gold Coast can help you avoid many of the pitfalls of growing your business and ensure you maintain a healthy business cash flow.

We’re also able to offer outsourced CFO services which can be completely tailored to the needs of your organisation. From cash flow planning and management to helping you reduce the risks your business is exposed to, talk to one of our CFO consulting partners today.

This blog was first published in October 2016 and updated in April 2025.

Disclaimer: This information is general in nature and does not take into account your individual objectives, financial situation, or needs. You should consider seeking professional advice before making any financial decisions.

As business owners we all want to create a growing and thriving business.

However the reality is that some of us manage to achieve this while others seem to potter on in a hard-earned but stagnant existence.

I recently ran a workshop with 15 high growth businesses and we discussed just this. After much debate it became clear that every successful organisation we could name had a very certain and passionate purpose and a clear vision.

I don’t mean the text book statement of purpose that we all learn about in our university days either.

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Let me explain.

Each great business understood exactly why they existed and could articulate what it was that made their teams turn up to work each morning.

For example:

Oxfam exists to create a just world without poverty.

Multiple Sclerosis Foundation exists to create a world free of MS.

Temple and Webster exists to be Australia’s most beautiful shopping experience for the home.

These statements aren’t the voluminous, meaningless waffle that we were traditionally taught a statement of purpose should contain or that you so often see hanging on a company’s wall.

They are a clear one sentence statement that describes what it is that is driving the business.

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Understanding the why factor

I watched a TED talk by expert Simon Sinek which explains this further. Click here to view this talk.

Sinek argued that people don’t buy what you do; they buy why you do it. Meaning they buy on emotion and then rationalise it with logic.

And yet most businesses focus their marketing communication on non-emotional things like facts and features.

This is because most businesses know what they do but very few know why they do it.

So where does this leave you if you are like many of the business owners I meet and haven’t thought about the very reason your business exists?

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As the year draws to a close take the time to reflect on your purpose and vision

1. Start by reviewing your ‘why’/purpose
   Your why is the inherent driver for you and your business. It is not to make a profit. That is the outcome of doing what you do but it is not why you do what you do. If you are struggling with clarifying ‘why’ your business exists consider using a mind mapping process to expand your mind and provide focus and clarity.
2. Use your purpose to help define your vision.
   The next step is to develop your vision. If your purpose talks to your heart, your vision talks to your brain. It describes the long-term desired change that results from your organisation’s work and provides a mandate that all work can be measured against. This is your inspiration for rallying your troops. In other words it captures exactly where you are heading to achieve your purpose.
3. Use both your purpose and vision to guide everything you do
   Your vision should set the direction for how you interact with staff, market to your customers and the criteria you use to make decisions.

Fine-tuning your vision into something that is inspirational can be a real challenge. But with so few businesses really understanding why they exist – this is an opportunity to stand out from the crowd and is the first step in building a growing business.

Of course developing your vision is just the first step to creating a high growth business. In our next newsletter we will discuss how to turn your vision into action.

The Federal Government has indicated that they are very keen to support innovative businesses. There are a number of funding options available by way of government grants for businesses that can meet the Government qualification requirements.

If your company has been “experimenting” to try and solve a problem in your business for which there was previously no useable solution you may be eligible to claim those activities under the Research & Development (“ R &D”) Tax Incentive. If you believe your company may qualify you need to register with AusIndustry. That body will determine if your process meets their innovation requirements and, if you are successful, will provide you with a registration number that is then incorporated into your company’s income tax return where you make your claim for the Tax Incentive. There is a separate round of incentives each financial year. Registration is undertaken in the months following the end of the year during which you incurred the costs. Therefore you need to first incur the costs and then seek the incentive after the end of the financial year.

For the 2017 financial year the rates of assistance under the R&D Tax Incentive are 43.5 per cent for eligible entities with a turnover under $20 million per annum and not controlled by a tax exempt entity and 38.5 per cent for all other eligible entities.

The incentive is obtained either as a refund of cash in circumstances where the company has no taxable income or as a rebate of tax where the company does have taxable income.

The R & D Incentive is complex and you should seek advice to assist you to make the appropriate claim. You should be particularly aware that the applicant for grants must be a company.

The Federal Government also operates an Entrepreneurs Programme that provides assistance to innovative businesses. Of particular interest is the Accelerating Commercialisation Grants, which is a merit based programme that encourages and assists small and medium businesses, entrepreneurs and researchers to commercialise novel products, processes and services.

This grant provides up to 50% of expenditure to a maximum of $1 million and includes access to an expert network as well as access to promotional opportunities. More details can be found at https://www.business.gov.au/assistance/accelerating-commercialisation.

A recent addition to assistance available is taxation incentives for investment Innovation Companies. Unlike the R & D Tax Incentives, this scheme is available to persons who invest in companies that qualify. The system is designed to encourage high net worth taxpayers who qualify as “sophisticated investors” to investment in innovative businesses.

The incentives include a 20% non-refundable carry-forward tax offset on investment in eligible companies, capped at $200,000 per investor, per year and a 10 year capital gains tax exemption for qualifying investments held for at least twelve months. For further details of this scheme refer to http://www.innovation.gov.au/page/tax-incentives-investors

You should also be aware that there is also a raft of incentives and assistance available from the various State Governments around Australia. Your local MGI firm will be able to provide you with more specific details.

Can a business have too much cash? I was recently asked by a client whether they were holding too much cash in the business. My answer was – it depends.

It depends on a number of things as well as the reasons for the cash build up. There are economic, commercial, financial and structural issues to be considered.

As a general rule, having plenty of cash on hand is a good thing particularly for those businesses in cyclical industries such as the resource industry. Such industries can have downturns which can last many years, so having plenty of cash on hand is important. Even if you’re not in a cyclical industry, it pays to have access to cash for a “rainy day”. After all, there’s only one reason businesses go broke and that’s because they run out of cash.

Also, if you’re a fast-growing business you’ll need all the cash you can get your hands on. Cash is king and high growth businesses are in danger territory. Having the necessary cash to fund that growth is crucial.

However, sometimes cash just builds up over time from a prolonged period of profitability. In this case, it begs the obvious question as to the need for the cash, particularly if the cash is simply sitting in a bank account earning nominal interest. To me, this is an obvious sign of a lazy balance sheet. If there is ample cash to fund your working capital needs and there are no obvious plans to use the capital to grow the business then I would argue that the surplus cash should be returned to the shareholders of the business.

If the business is privately owned, the funds can usually be lent back to the business at a later date should the need arise.

Asset protection might be another reason to return surplus cash to shareholders. Leaving the cash in the business means that it is potentially at risk of claims from creditors or other parties. Once it is paid out to shareholders then it is generally no longer at risk in the business.

Having excess cash in a business is just like having a beach house in a business. You wouldn’t do it. Similarly, if you’ve sold a significant asset that is no longer needed and you have cash from the sale that is not needed to fund or grow the business, then it should probably be returned to shareholders who may have a more productive use for the funds.

If you’re actively measuring and managing the financial drivers of the business you’ll soon realise if you’ve got excess cash. This is because you’ll start to experience the symptoms of a “lazy” balance sheet – a falling return on capital employed (ROCE). More cash means you have to make an appropriate return on that. If it’s only earning 2%-3% then your ROCE will start to fall and you should see that trend starting to develop.

More importantly, a “lazy” balance sheet can often lead to other “lazy” practices. If there is ample cash, your team may not be as motivated to chase payment from debtors. As debtors take longer and longer to pay, the risk of default increases which means you may end up with more bad debts. Ultimately, these will come home to roost. Similarly, ample cash may mean your team are not as motivated to maintain appropriate stock levels, which could result in a blow out in inventory.

Sometimes these “lazy” practices manifest themselves into a business threatening culture from which the business may find it hard to recover. The cash stockpile gets run down due to the lax attitude. Couple this with ballooning stock holdings and debtor book and you may encounter a “perfect storm” that you never saw coming and it may be too late to avoid.

So, the appropriate amount of cash to have on hand is all about balance. Not too much, not too little. Keep an eagle eye on your ROCE, working capital burn rate and free cash flow and you should have ample cash to fund the business.

 

I’m often asked by business clients whether a certain dollar profit is good. My answer is always the same – it depends.

The fact is, no one can tell you whether a specific dollar profit figure in isolation is a good result or not. It’s just like asking someone whether the $1,000 in interest you received from the bank is a good return. You can’t answer the question until you know how much they had invested in the bank – and so too it is with a business.

In my experience, the problem is that very few business owners have any idea of how much they have invested in the business. Without this vital piece of information you only have half the picture. This is also often the case in the financial press, with banks often being criticising for the “obscene” profits they make without asking one vital question – how much did they have invested in the business and what rate of return is that?

So, my Big 3 ratios on which to asses the financial performance of a business are:

1. Profitability – what is the percentage of profit to sales? This will be a percentage (e.g. 10%).
2. Activity (or Asset Turnover) – Sales divided by the total assets of the business. This is a number (e.g. 2). Simplistically, your total assets is your Plant & Equipment, Stock, Debtors (and other working capital) less Creditors.
3. Return on Capital Employed (ROCE) – 1 multiplied by 2 (e.g. 20%).

Once you know what the ROCE is for your business, then you can assess whether this is sufficient for the risk you’re taking.

We all know that you can get around 3% investing in supposed “risk free” ten year government bonds so why would you accept this rate of return in your business when it is certainly not risk free. Similarly, we all know that, over the longer term, you can expect a return of around 10%-12% investing in a portfolio of publicly traded blue chip shares. Sure, returns since the GFC have taken a hit, but I’m talking about the longer term.

Therefore, why would you accept this rate of return in your business when it is more risky than a portfolio of publicly traded blue chip shares? This starts a discussion about how much more risky your business is and what you can do to reduce that risk. Is 20% return enough? Is 30%?

It also starts a discussion about how to improve the financial performance of your business.

It follows from our Big 3 ratios above that ROCE is a function of Profitability and Activity. Therefore, the key to increasing ROCE is to understand whether it is your Profitability that is poor or your Activity, or both. More importantly, if you made changes to one of them, which one would give you more “bang for buck”. That is, a small change in one area may have a multiplied effect. The key is knowing what the “driver” is for your business.

Why not try to assess the ROCE for your business using the formula below? Feel free to contact me if you get stuck.

ROCE = Net Profit/Sales  x  Sales/Total Assets

This formula can be further simplified to:

ROCE = Net Profit/Total Assets

Of course, it is simplistic to say that all of your business problems will be solved by simply concentrating on only these three ratios. But it is an easy start. There are many other financial ratios that are important in running a business, including liquidity ratios and measuring free cash flow.

In a recent article, Planning to Take Control of the Family Business, I talked about the reluctance of family and privately owned business to plan. I opined that “time pressures” and “not knowing where to start” were two of the main reasons for this reluctance.

However, I believe there is another, very important, reason for not planning – basically, a lack of desire. Or, in other words, not enough discontent with the status quo. If the business owner is “content” with the way things are, why plan, why change?

So, how do you assess whether the business owner is “content” and therefore whether there is a desire to plan and a desire for change?

I use a simple model to assess the change potential of any business using the formula:

D x V x P = Change Potential

So, what do D, V and P stand for?

The “D” stands for dissatisfaction or the extent to which you are unhappy with the current position of the business. It is the “why” – why change?

The “V” stands for Vision and represents the extent to which the business has a clear, documented vision which is shared with the key stakeholders. The vision provides the direction. It is the “what” – change to what?

The “P” stands for Plan and represents the extent to which the business has a clear, documented and communicated plan with time and date actions (i.e. who has to do what by when). It is the “how” – how will we achieve our vision?

I then ask my clients to provide a score from 1 to 10 (with 1 being low and 10 being high) for each of D, V and P. What is interesting is that sometimes there is considerable variance in these scores between the various stakeholders, particularly between key employees and the owner of the business. This in itself opens up a worthwhile discussion.

So for example, if they have a documented plan but it is not communicated to key stakeholders and/or it doesn’t have time oriented actions attached to it, then you might rate the “P” as say a 4 or 5. Similarly, if the owner of the business has a vision for the business that is in their head and is not communicated to their team, then you might rate the “V” as say a 3 or 4.

However, in my view the level of the “D” is extremely important in determining the change potential of a business and therefore the likelihood of success in implementing the plan. This determines the level of motivation the stakeholders have to change and therefore the level of motivation to plan for something different – the “fire in the belly” if you like.

If there is a low “D” and all stakeholders are content with the way things are going, why would they be motivated to change? In addition, many people fear change particularly when it is imposed upon them.

Mathematically, then if the scores to the “D”, “V” and “P” are say:

5 x 4 x 3 then the product is 60. Given that the maximum possible score (10 x 10 x 10) is 1000, then to get a percentage simply divide the calculated number by 10. Therefore, in this example, the likelihood of the business implementing change and improving itself is only 6% – a very low likelihood.

However, if for example the scores were a high level of dissatisfaction with the status quo (say 9), the owner has a clear, documented and communicated vision (say 8) and there is a written action plan as to who has to do what by when (say 8), then the likelihood of the business implementing the plan and achieving the vision is much higher (9 x 8 x 8 = 57.6%).

As a final point, if the level of ‘Dissatisfaction’ of the owner is very low or does not exist, (e.g. zero), then any number multiplied by zero equals zero. Therefore, if “D” is zero so too is the change potential, or impetus to change, of the business even if there is a clear documented vision and a detailed action plan. There has to be a desire for change.

The challenge then is to convince the stakeholders of the need for change and that remaining as they are is not an option.

If you would like to find out more about applying this model in your own business or any other aspect of business planning, please feel free to contact me or take advantage of our free Business Development Consultation.

 

We’ve all heard the saying before: Cash Is King! But what does it mean and why is it so important? Cash is essentially the blood that pumps through the veins of a business and keeps it alive. In most businesses, both small and large, problems occur when their cash flows are managed poorly and cause both owners and their employees’ significant stress. So in these more uncertain economic times, how does a business manage its cash flow to ensure its continued success?

There are a number of simple strategies that can be used to help improve and manage cash flow.

1. Project monthly sales/prepare cash flow forecasts

When it comes to how to manage cash flow it is all about timing: when your sales are likely to come in and when your expenses are likely to go out. A business can be profitable from an accounting perspective yet still have cash flow problems.

To assist with cash inflows, a cash flow forecast on the timing of sales is an important tool. This will identify those months where cash flows could become tight and allow you to manage cash outflows. When preparing cash flow forecasts, it’s important to be realistic rather than overly optimistic. Use a worst-case scenario, review regularly and update when circumstances change.

2. Manage your debtors

Debtor management is a key component of any business. A sale isn’t a ‘real’ sale until the cash is deposited into your account. Debtor management has become more critical then ever given the slow down in the economy and the reluctance of consumers and businesses alike to part with their cash.

Some ways to improve your debtors include:

• Set credit limits for customers and monitor these closely.
• Conduct a credit check for all new customers
• Potentially offer a discount for paying their invoices early. For example, look at your recent rates bill. Council gives you $15 off if you pay on time and is hugely successful in ensuring that debtors are paid and regularly cash flow is achieved.
• Send invoices out immediately. Don’t wait to the end of the month if the work has been completed.
• Bank daily
• Review aged debtors report regularly and follow up when customers have fallen outside of their agreed credit terms.

3. Manage your stock efficiently

Large amount of free cash flow can be ‘locked’ away in your inventory levels. However, the difficulty with stock management is that there is a fine line between having just enough stock on hand to meet the needs of your customers and having either too much or too little. In my experience the risk is that companies buy too much and are left with large amounts of excess stock which end up being heavily discounted to sell or even worse, is written off and discarded.

So how do you improve your stock management? Some ways include:

•  Have a regular review of stock levels. Identify those lines that are not turning over regularly and look at discounting these to clear it from your storage facility.
•  Don’t buy too much even if it’s offered at a discount. This could tie up unnecessary free cash flow and also increases the chance that you won’t be able to sell the stock.
•  Set minimum and maximum levels of stock lines and stay within these limits.

4. Control your expenditure

Regularly reviewing your expenditures is a must. Have a rolling budget and compare these to prior periods. If any expenditure is significantly different to what you budgeted for, investigate why.

Others ways to control your expenses include:

• Always look at ways in which you can cut your expenditure. Have your staff look out as well and assist you in this role.
• Require quotes for any major expenditure items. Always seek fixed prices to know exactly what cash flows you are likely to face and whether the company can afford it.
• Prepare regular financial reports – always know how the business is tracking.

5. Watch the timing of your cash outlays

Cash outflows are an area in which you have a greater level of control. Look at ways to minimise outflows and try to have these reflect your cash inflows. For example, if you know your business is seasonal and achieves most of its cash flows in the first half of the year; try to match your largest expenditure items when cash flow is easily accessible.

Other ways to improve the timing of your cash outlays could include:

• Negotiate with your suppliers a discount for paying early or up-front.
• Always pay your creditors on the day the invoice is due – don’t pay early or late.
• Negotiate longer payment terms on a payment plan if cash flows are tight. Many businesses will be happy to put you on a payment plan if they can see that you are going to pay your bill. The sooner you talk to them about this the easier it is.

6. Remember your tax obligations and its impact on cash flows

While no one particularly likes paying tax, it is part of any successful business. A business paying tax is a profitable business and I would much prefer to be paying tax then having a large amount of carried forward tax losses. However, this doesn’t make it any easier when you are required to send that cheque to the ATO with your BAS.

Tax commitments, whether GST, income tax, PAYG, FBT instalments can be quite substantial and can cause businesses some cash flow issues if funds are not put away regularly. Adjust the amount that is put away depending on the level of sales/profit that the business generates each month.

7. Adjust for Growth

It is critically important to understand the additional cash flow that is required when a business is growing. Many successful businesses fail by not having sufficient cash to fund their growth operations which can leave the business vulnerable. New sales generally require additional resources such as new equipment, employees, marketing and potentially larger premises. This increase in fixed costs can occur even before new cash flows from expansion have even begun.

Whether the plan is to have the status quo or to enter into a growth phase, a cash flow strategy is a must for any business. By looking at how to manage cash flow effectively you will ensure that the business remains successful and reduces the stress. As the saying goes: Cash Is King!

A new year is traditionally seen as a time to make resolutions for change. I therefore thought it might be useful to provide you with my top tips for good financial health.

In a previous blog, Three Key Ratios for Business Success, I talked about the need for any business to achieve a certain rate of return on the capital invested in that business.

Tip #1 – Realise that your business is just a pot of money – your money. Conceptually, every business is the same. They use capital to produce a profit. In our “pot” we usually put equity capital (money belonging to the owner and reinvested profits) and debt funding (obtained from the bank, leases, HP’s etc.) – the inputs of the business. Out the bottom of the “pot” drops sales, less expenses to leave a profit – or the outputs of the business. The key is to maximise outputs and minimise inputs.

Tip #2 – Decide what rate of return you want from your business and think about how you have arrived at that rate. After all, you can get 4% in ten year, risk-free government bonds. On a broad portfolio of publicly traded blue chip stocks you should expect a long term average of around 12%. Therefore, you should generally expect a higher rate of return for your business, which is not publicly traded (i.e. easily sold) and usually in one industry, not a broad portfolio of companies.

Tip #3 – Know and understand the financial “drivers” of your business. Is it volume/sales driven? Is it margin driven? Is working capital a key driver or are you in a capital intensive industry with large investment in plant and equipment? It’s no use selling more if it is at the expense of margin and you end up making less profit. Either way, you need to know in what area, changes will give you more “bang for buck”.

Tip #4 – Many small changes can make a big difference. Some business owners think their panacea can be achieved by simply increasing prices or increasing sales. Based on my experiences, small achievable changes made to a handful of areas can have a multiplied effect on return on capital employed (ROCE). Focus on the key driver for your business (Tip 3) but also look at other areas including working capital management, under-utilised assets and margin.

Tip #5 – Plan to get a certain ROCE. Don’t just expect it to happen. Once you’ve decided on the minimum rate of return you want from your business (Tip 2), do the necessary financial modelling so that you know what needs to change (Tips 3 & 4) in order for you to achieve your desired return.

Tip #6  – Finally, profit is opinion – cash is fact. Know and understand what your free cash flow (FCF) is. You can still make a profit but have no (or negative) cash flow. This is because management decisions and accounting policies have an impact on how profit is reported. Assumptions are also made regarding depreciation rates for plant and equipment and these also impact on profit. Businesses are also growing, which means more and more cash is chewed up in more and more stock, debtors and plant. Many fast-growing businesses have gone broke through lack of cash flow.

As an adviser to family and privately owned businesses, I have business clients of various sizes. Some are large, high growth businesses with hundreds of employees and multiple offices. Others are what might be considered ‘small’ (e.g. sales of up to say $5m), however similar issues are shared by all of these businesses.

It seems like every second day I read about another business going into liquidation.

This past year has seen a number in the transport and logistics industry, the most recent being Gregorys Transport. This begs the question – why?

Businesses in this industry operate on small margins and invariably have a lot of money tied up in their trucks. In many cases, these vehicles are owned or leased from a finance company. This means they are effectively a fixed cost and can’t be “turned off” if business drops. The newer the fleet, the greater the capital invested and therefore the greater the fixed cost.

In contrast, a business that contracts out part of its business to owner/drivers has much more flexibility. If business falls off, then it becomes the problem of the contracted owner driver and the business can continue to keep its own trucks busy.

The same principle can be applied to a number of businesses. I saw this when there was a hiccup in the mining boom a few years ago. During the boom some businesses in the resource industry supply chain geared up and bought more new equipment in the belief that this was the new “norm”. Others retained their existing equipment and hired in part of their equipment. When the bubble burst, the latter businesses simply handed the hired equipment back to the hirer. Some of the businesses that geared up with new equipment went to the wall.

Sure, the profit margin on the hired equipment wasn’t as high as on the owned gear (due to the cost of hiring), but it certainly reduced the risk of the business and as we know, higher risk and higher return generally go hand in hand.

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So, what are the warning signs for your business?

There are two key warning signs that I look for in any business.

Firstly know the dollar value of the capital you have invested in your business. This includes your stock, your debtors and your capital equipment. Most business owners can tell you what profit they make, but they can’t tell you their capital employed. If this is (say) $10 million and your profit (EBIT) is (say) $1million, then that’s a 10% return on your capital employed (ROCE). For most privately owned businesses that’s not enough given the risk involved.

ROCE is made up of two components – profitability and asset turnover (or activity). Naturally, profitability is simply the percentage that your profit (EBIT) bears to your sales. So, EBIT of $1million on sales of $10million gives a profitability percentage of 10%. This is only half the picture.

Asset turnover (or activity) is the big sleeper that very few businesses have their head around. In other words, how many sales can you generate for the capital employed in the business? If you generate sales of $10million on capital employed of $10million then your activity ratio is 1. This is probably too low and may be a sign of a “lazy” balance sheet.
Depending on the industry, you should generally be above 3 unless you have very high profitability. The multiple of your profitability percentage (in this case 10%) and your activity ratio (in this case 1) is your ROCE (i.e. 10%).

In the transport industry (or other capital intensive industries), your activity ratio will generally be low. That means your profitability ratio needs to be higher to compensate. When profitability is also low (as can be the case in road transport) then you are stuck between a rock and a hard place. Getting the mix right between your profitability and your activity ratio is key.
The second main point to understand is to know your free cash flow (FCF). As the name suggests, free cash flow means “available” cash flow – cash that is available for use in the business. If you don’t have free cash flow you’ll eventually go broke (that is, you have negative free cash flow). There are only three reasons why businesses don’t have cash (i.e. free cash flow).

1. They’re growing too fast. That is, the dollar increase in working capital and equipment is greater than the profit the business generates.
2. They’ve used short term working capital to fund long term assets. This is relatively easily fixed through a sale and lease back arrangement.
3. The business is not profitable. So you don’t have a cash flow problem, you have a profitability problem (which goes back to point 1 above).

If you don’t have your finger on these two key business parameters you’re flying blind. If your business also has a lot of money invested in capital equipment then you’re really in danger territory.

There can only be three reasons why these businesses find themselves going into administration. Either they are getting poor financial advice, are getting good advice and not implementing it, or are not seeking the appropriate advice in the first place. Most of my experience has been with the latter.

It’s not rocket science. Invariably, the business runs out of cash-flow and there are only three reasons businesses don’t have cash; and this applies regardless of the size of the business.

There are a lot of business owners that simply don’t know what they don’t know. That’s not intended to insult business owners; it’s a challenge for those of us advising family and private business. Business owners are busy building their business. They’re good at what they do and that is their focus. Our challenge, as advisers to business owners, is to raise awareness of the benefit of having access to that advice.

As an example, what continues to surprise me is that very few business owners know what rate of return on capital employed they’re making on their business and whether that rate of return is high enough. Most business owners can tell you how much profit they made in dollar terms, but from my experience, what they can’t tell you is how much capital they had tied up in the business.

This simple ratio is an all-encompassing measure of financial performance and should be the first ratio business owners ask for from their financial advisor.

After thirty years advising small business owners, it’s still surprising to see that many don’t read the signs and seek help early enough. Many even end up using the ATO as a banker to fund their growth.

The key is to surround yourself with competent financial expertise, know what questions to ask and make sure you have appropriate financial reporting systems in place to ensure you receive accurate, timely financial information.

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Here are some key indicators to determine if you’re receiving adequate financial advice about your cash flow situation:

• Most businesses don’t take into account that growth for growths sake is not always the best thing for the business. High growth means high risk and businesses need to surround themselves with competent financial expertise to manage that risk.
• If your financial team can’t tell you what your free cash flow is, they shouldn’t be there. No matter how profitable your business, you can still have negative free cash flow. This means that even if you’re making a profit, your business is growing at such a rate that the profit is not sufficient to fund the growth. This means having to borrow more and more from the bank until there’s a hiccup and the bank says no more.
• Know your Sustainable Growth Rate. How much can the business afford to grow without requiring disproportionate debt? Your financial team should be able to tell you what this is. Growth funded entirely on debt is dangerous growth.
• Know your working capital absorption ratio. This is a simple ratio that you particularly need to know in a high growth business. In other words, how much additional working capital is needed to fund a given increase in turnover?
• Another key reason why businesses don’t have cash is that they are not profitable. It doesn’t have a cash flow problem; it has a profitability problem. It may have a history of prior losses as well as the current year. These losses have to be funded from somewhere and that is usually from the shareholders, or more likely, the bank. Ultimately there comes a time when the bank says no more.

Do you have the right financial information to help you make the best decisions for your business?