Financial Performance Archives | Page 4 of 4

The recent collapse of the Dick Smith chain highlights the fact that no business is immune from potential catastrophe. But it begs the obvious question – how can a company as big as this and turning over $1.3 billion – a listed company – fail?

No doubt we’ll hear more in the months ahead as the receivers get to work. However, the lessons are the same for every business – from the corner store, to family businesses, to listed companies.

Fundamentally, there is only one reason that businesses go broke – they run out of cash. So how do businesses (even listed ones) run out of cash and what can you do to avoid it happening to your business?

There are basically three reasons businesses run out of cash.

The first reason is they’re not profitable. They don’t have a cash flow problem; they’ve got a profitability problem. In other words, the lack of cash flow is a symptom of poor profitability (or even losses). Unless you fix your business model and restore profitability, you’ll never get cash flow under control.

I note from prior year annual reports of Dick Smith Holdings Limited that the company had after tax profits of about $19m and $37m in 2014 and 2015 respectively. I also note that an ASX announcement by Dick Smith’s on 28th October 2015 states that the company anticipates 2016 after tax profit being $5m to $8m below previous guidance of $45m to $48m. Whilst the profit outlook was reduced, the company still appears to be profitable.However, it has come to light that the company has significantly written down the value of its stockholding by $6m, effectively wiping out the prior year profits.

The second reason businesses run out of cash is that they use short term working capital to fund the acquisition of long term assets. In other words, they use their working capital (short term funding) to purchase plant and equipment or property (long term assets). If your business is growing rapidly, this is a big no, no. You’ll need that working capital to fund your growth, particularly larger inventory holdings.

In most cases, this issue can be fixed by a sale and lease back of the assets (assuming funding is available). The key is never to use your working capital to acquire long term assets unless you’re absolutely sure you have significant excess and know that you won’t need it in the near future.Again, based on my assessment of the Dick Smith’s annual reports for the past three years, the value of plant and equipment appears to have grown by around $32m from the 2013 year end to the 2015 year end (after allowing for depreciation of about $28m).The cash flow statement indicates that the total amount paid for plant and equipment over the two years was closer to $60m.Bear in mind that after tax profit for 2014 and 2015 totaled around $56m and dividends paid in 2015 were around $35m, which is effectively funded by those accumulated profits. Once that is taken into account, available profit is $21m. If my figuring is correct, this would not be sufficient to fund the above increase in plant and equipment.

The third reason that businesses run out of cash is that they grow too fast. Yes, businesses can grow too fast and it is a situation I see all too often.

Make no mistake, a fast growing business is potentially in danger territory, particularly if it doesn’t have access to an endless supply of funds – and which businesses have that luxury? For many fast growing businesses, this means holding more and more inventory. As the business (and sales) grows, more of the profits are required to be used to invest in more and more inventory to stock more and more stores. If you’re in a business where margins are tight – whammo! – you have lower profits to fund ever increasing inventory. If you also happen to have a business where you give credit terms to your customers, then not only do you have a build-up of inventory, but you also have a build-up of debtors. These have to be funded from somewhere. Unless the business is highly profitable, the profit alone may not be enough to fund that growth. This invariably means going to your friendly banker – and as appears to be the case with Dick Smith – there is a limit to which banks will be prepared to fund your growth.

Again, I note from the company’s past annual reports that inventory levels have increased by around $122m from 2013 to 2015 and debtors (accounts receivable) increased by around $43m, a total of around $165m. This has to be funded from somewhere and if profits aren’t sufficient, then usually the banks are the ones who fund it.Interestingly, the ASX Announcement by Dick Smith Holdings Limited on 18th August 2015 states that since the company’s Growth Strategy was implemented 30 months ago, the company has opened 70 new stores. The company’s 2015 annual report states that 25 new stores were opened in that year and that it intends to open a further 15-20 new stores in 2016.

In my view it is therefore not surprising that the company entered into a $135m syndicated lending facility on 22nd June 2015 (as per its annual report), of which $70m was drawn prior to the June 2015 year end.

No doubt there were other factors at play, however in my opinion the Dick Smith business failed due to a combination of all three of the above reasons. It grew too fast, used short term working capital to fund long term assets and (ultimately after stock write downs) wasn’t profitable. The bottom line is that there was insufficient profitability or insufficient access to funding for growth.

As the saying goes – turnover is vanity, profit is sanity but cash flow is reality.

So, what are the lessons for business owners and particularly fast growing business owners when it comes to managing cash?

In my view there are three key measures every business should be checking on a regular basis, but particularly fast growing businesses.

Your Free Cash Flow is a critical measure. Free Cash Flow (or available cash) is simply that. It is the amount of cash you have left out of profit after funding the increase in size of your business. If you’re not measuring and monitoring this then you’re flying blind.
Your Working Capital Burn Rate. This is simply the amount of working capital (debtors plus stock less creditors) as a percentage of sales. If this is (say) 25%, then you know that for every additional $1m in sales, you’re going to need $250k in working capital to fund that growth.
Your Sustainable Growth Rate. This is simply the rate of growth the company can sustain without adversely affecting its proportion of debt to equity funding. It’s called “sustainable growth rate” for a reason.

Vibrant, growing businesses have an important role to play in our economy. The key is to be able to sustain that growth and it is only by keeping a watchful eye on key financial parameters that this growth can be sustained.

If you are not measuring the three key ratios mentioned above then you are flying blind.

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 cash flow.

Project monthly sales/prepare cash flow forecasts

Cash flows are 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.

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.

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.

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.

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.

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.

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 managing your cash flow 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.

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.

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?

It’s usually easier to look back after a business has failed and identify why, than it is to save a struggling business from failing in the first place. In my view there are a number of reasons for this, not the least of which is the fact that everyone is always wiser with the benefit of hindsight.

However, it begs the question of what a business owner can do if their business is struggling? After all, they have a lot of their heart and soul invested into the business (as well as their capital). It’s their “baby” and they are convinced they’re onto a winner, even if it isn’t working out.

The answer is – it depends. It depends on many variables including what type of business they’re in, what industry it’s in, where it’s located and what size the business is and what stage it is at in its lifecycle. In my experience, scale can often play a huge part. There are many struggling business owners out there – some might call them micro businesses.

But there is hope. Here are my top four tips to get your business back on track.

Do you know your breakeven point?

When I walk past retail outlets (clothing shops for example), I often wonder if the owner knows how many (or what dollar value) of clothes they must sell each and every day in order to simply breakeven.

One thing many businesses fail to do before even setting up business is a simple breakeven analysis. A business broadly has two types of costs – fixed and variable. As the name suggests, fixed costs are largely fixed in nature. This means you’ll have to pay these whether you sell one item or one million. Whilst all costs are variable over time, rent might reasonably be regarded as a fixed cost. You will have this cost even if no customers walk in the door.

Variable costs are simply those that vary with your sales volume. If you are a wholesaler or retailer, the cost of your product might be a variable cost.

So, tip number one would be to understand your breakeven sales point (on a yearly basis) and then break this down to a daily or weekly basis i.e. how many items do you have to sell each day or each week. Then develop and implement strategies to help you sell more than this quantity.

Can you afford to grow?

A struggling business might be able to grow its way out of trouble, but do you have the necessary cash to fund that growth? Do you know how much cash you’ll need to fund your desired growth?

In order to answer that question you need to know one critical measure – your working capital burn rate. If you don’t know this you’re flying blind. I often see businesses targeting a certain percentage increase in sales. When I ask them how much working capital they’ll need to fund that growth they often don’t know. Sales generally don’t fund themselves.

For some businesses their working capital burn rate can be quite high. These businesses will struggle to fund rapid growth. For others it can be quite low, in which case they will have an easier road.

You need to know yours.

What are the financial drivers of your business?

Every business has what I call financial drivers. If you don’t know yours you may as well be driving a car without an instrument panel on your dashboard. You don’t know how much fuel you have, whether your engine is overheating or whether your oil is getting low. It’s the same with your business.

Various businesses respond differently to a given intervention. In other words, some businesses are volume driven – they perform better the more goods they sell. Others are margin driven – they don’t necessarily need to grow at the same rate, but they make more profit on the items they sell. Once again, how your business responds will depend on a number of factors including the current size of your business and your breakeven level.

Some businesses require large amounts of working capital e.g. stock and debtors, and can therefore respond well to small improvements in working capital management. Others may have what is called a lazy balance sheet, with a number of underperforming assets.

The key is to understand your key financial drivers – changes in these areas will give you the biggest bang for your buck and potentially turnaround a struggling business.

The key measure of business performance

Finally, you need to focus on my one key measure of financial performance. In my view, this is Return on Capital Employed (ROCE). Understand how much capital you have invested in your business and focus on deriving an acceptable return on that.

If your ROCE is not acceptable, you’ll know where to focus your attention.

Is your profit margin too low?
Do your sales need to grow?
Are your expenses too high?
Do you have poor working capital management?
Do you have a lazy balance sheet?
Are you paying suppliers too quickly?

The answer is usually there somewhere. You just need to know where to look.

Often business owners let their heart rule their head but unless they remember that they also have capital invested in the business and act in a mercenary way, they could end up with a broken heart and zero capital.

If you would benefit from support for your struggling business, we have a number of specialist business advisors who can help with business benchmarking, business growth and business funding. Contact us today for a coffee and an informal chat.

I often read about businesses that don’t last the distance – businesses that look like they have great potential but just somehow can’t be sustained. I can’t help but think that many of these organisations mustn’t give any thought to “future proofing” their business.

So what is “future proofing” and why can it help businesses survive?

The literal definition of future proofing is: the process of anticipating the future and developing methods of minimising the effects of shocks and stresses of future events. Sounds a lot like planning doesn’t it? You’ll also note the significance of the word “process”. This suggests that future proofing is not about one-off gimmicks or quick fixes – it is a course of action, an ongoing function.

The definition also talks about minimising the effects of future shocks. So, here are my top four tips to future proof your business.

Tip 1: Get your business into a strong financial position.

If future proofing is about minimising the effects of future shocks, then the best way to do this is to have a “war chest”. Make sure that your business is profitable and has strong free cash flows. That means that if you lose a key customer you can withstand it better than if your business was operating on a “line ball” basis.

In a previous blog I talked about my top three ratios for business success. Profit, in and of itself, is not enough. It needs to be strong profit, with an acceptable level of return on capital employed (ROCE). However, profit is opinion, cash is fact. Just because you’re making a profit doesn’t mean the business has free cash flow.

Your business may be growing so fast that all of your free cash flow is injected back into the business. This is how businesses go broke unless they have an unlimited source of money from outside the business, which is rarely the case. Once again, I recommend that you refer to my blog, Three reasons businesses don’t have cash, for more information on this area.

Tip 2: Have a structured process.

As the definition of future proofing suggested, you need to have a process. One off, uncoordinated attempts at “quick fixes” will not do it.

An approach that I use is “now, where, how”. Not rocket science, but effective. The process starts with assessing the “now” or current reality for the business. Unless we understand where we are we can’t move on. We use a number of processes to assist in this. These include a strategic SWOT analysis, which not only looks at the strengths, weaknesses, opportunities and threats of a business, but also builds strategies on, for example, how we can use our strengths to capitalise on our opportunities.

Next, we need to understand “where” we want to go before we get into ‘solution mode’. As the saying goes – if you don’t know where you’re going, any road will get you there. Again, having set processes to assist in developing the vision can be helpful. It is also important to understand the ‘raison d’etre’ for the business.

Tip 3: Develop an action plan

One of the biggest failings I see in planning processes is the lack of an action plan, with timelines and responsibilities allocated to specific people – who has to do what, by when. Many businesses run planning workshops. Everyone walks out of the workshop hyped up and raring to go but there is no action plan and therefore no accountability. Strategy without action is only a daydream.

Tip 4: Don’t fail to implement (FTI)

with an action plan, we all get tied up in the day to day operations of our business working in the business, not working on it. The result can often be that the action plan doesn’t end up getting implemented.

To ensure that this doesn’t happen, my process is to meet with the management team of the business on a monthly basis to ensure that the action plans are being implemented. An external facilitator can “turn up the heat” when the hard decisions have to be made, but also act as an impartial party to provide an external focus for the business.

Nearly every week we read about an Australian-owned business going broke – even though their turnover is in the millions.

Within the last week alone there have been reports of collapses including Trazlbat (with a $20m turnover) and Ultimate Creative Agencies (with around $12m turnover). The question raised by such developments is: how can businesses with this level of turnover possibly end up in administration?

Whilst not commenting specifically on the above two businesses, my general observation is that this should never happen to businesses with turnover of $10m or $20m. They have already done all the hard work in getting to this size. If a business of this size collapses I believe it is primarily because it is not getting appropriate financial advice, or it is not listening to, and then acting on, the advice that is being given.

It’s generally not rocket science why businesses go broke. Invariably it’s because they run out of cash and there are only three reasons businesses don’t have cash; and this applies regardless of the size of the business.

1. Grow too fast

Yes, there is such a thing as growing too fast. A business shouldn’t just take on a big contract just for the sake of growth.

Here are my four golden rules to ensure you’re not growing too fast:

Make sure you surround yourself with competent financial expertise. High growth can mean high risk. Ensure your financial team know what they’re doing.
Focus on free cash flow. 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?

2. The dangers of short-term capital

The second reason businesses don’t have cash is they use short-term funding (i.e. working capital) to fund long term assets. That is, they pay cash for big chunks of plant and equipment instead of funding it over the life of the equipment. Don’t get me wrong, if you have plenty of cash (more than you need to fund your working capital requirements), then by all means use that cash rather than borrowing. But make sure there is plenty of spare cash to fund working capital, particularly if your business is growing fast.

3. Profitability is paramount

The final reason businesses don’t have cash is that they are not profitable. It doesn’t have a cash flow problem; it’s got 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”. What surprises me (based on my experience) is that very few business owners know what rate of return on capital employed (ROCE) they’re making on their business and whether that rate of return is high enough.

Once again, surrounding yourself with good financial expertise will pay off in spades. If your current financial team are not providing you with your ROCE ask why not and ensure they do. Most business owners can tell you how much profit they made. 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.

What still surprises me after more than 30 years advising SMEs is that business owners don’t seek help early enough. In many cases you find that the ATO is one of the major creditors, with businesses often using the ATO to fund their growth.