Working Capital

The truth is in the cash flow

The Value of a Virtual CFO

The Value of a Virtual CFO

Last week, I was talking to Bankwest about working capital management.

Most readers will know by now that working capital is a particular interest of mine.

This is because working capital is the biggest single use of a trading business’ cashflow.

So, by efficiently managing working capital, a business owner will release cash.

Cash that can be used to fund growth.

Cash that can be used to give you, the owner, more control of your business.

Cash that can be used to pay a dividend.

A Virtual CFO is a uniquely cost-effective and flexible resource available to business owners interested in being more self-sufficient, confident about taking a risk and building a sustainable business.

My job is not to tell what to do, or even what not to do.

My job is to help you understand the likely financial outcome of your business choices.

I am your partner, not your keeper.

If you are wondering about the value a Virtual CFO can bring to your business then take a read of the conversation I had with Bankwest – there are some great tips on managing working capital that you can implement straight away.

If you’d like more individualised help, please contact me.

Read More

Until the Pips Squeak

Until the Pips Squeak

This is the first article that I wrote on behalf of the Association of Virtual CFOs back in March 2016 and which was subsequently published by Smart Company.

It quantifies the amount of money Woolworths would inject into their cash flow by extending the time taken to pay their suppliers.

For business owners, this article is a great introduction to the importance of managing your working capital.

If you’re a business owner making a profit but feeling like you have no cash then the chances are your cash is being tied up in your working capital.

I hope you enjoy the article, and more importantly, find it useful and illuminating.

Lastly, if you’d like to turn your financial information into a source of competitive advantage, and grow your business with confidence, then please do make contact…I can make a difference.

Until the Pips Squeak.

Read More

It’s the Vibe (On Overtrading) – Part 3

It’s the Vibe (On Overtrading) – Part 3

In this final instalment on Overtrading I will look at the actions a business owner can take to remedy overtrading.

Have a Plan

Growth doesn’t happen by itself. There is activity that you, the business owner, is planning to follow in order to generate growth.

As such, you have the opportunity to plan at the outset for the resources you need to support your growth ambitions – be it more people, more equipment, more space or more cash.

You need to prepare a budget that identifies the expected financial impacts of your growth plan on your profitability, balance sheet and cash flow.

By having a plan and a budget you have operational and financial reference points against which to track your actual progress. It will quickly become apparent whether you are growing quicker or slower than expected and whether the actual operational and financial impacts are within or outside expectations. This frame of reference will help you decide what changes you need to make to your plan and the required resources to support the revised plan.

If you haven’t planned, and find yourself in an overtrading situation, then these are the steps you need to take:

Self Help First

Firstly, you need to stay on top of your working capital.

This means being disciplined with invoicing and following up with a good collection process.

It means identifying slow-moving stock and considering whether it should be discounted for a quick sale to bring in cash.

It could mean asking creditors for a temporary extension to your payment arrangements.

Essentially, you need to be doing everything possible to increase the amount of cash coming into your business whilst slowing the outflow of cash as much as is commercially feasible. This will buy you time to reorganise the people and equipment resources needed to support your growth.

An Operational Plan Next

Secondly, you need to fix any operational problems.

Do you have all the fixed assets you need to support the level of growth being experienced? Is additional plant and equipment needed? How much will it cost, and how quickly can it be installed and operating?

Do you have road blocks in your processes and procedures that are slowing down your productive capabilities? Ask your employees about this – you might be surprised by their insight.

Do you have the right number of employees to support the new level of business activity? How long will it take to find and train new employees? Is there a need to use a labour hire company to help out on a temporary basis?

Is it possible to sub-contract out some of the work whilst your labour and equipment requirements are brought into line with the new level of business activity?

Is it possible to reschedule delivery time frames whilst these activities are undertaken?

Will the business continue to be profitable once the new resources are deployed?

A Cash Flow Forecast Last

The financial effects of the prior two steps now need to be incorporated into a cash flow forecast. It should be a weekly based forecast for the first three months, moving to a monthly based forecast for the following 9 months.

If the forecast indicates a need for additional finance you are now in a position to approach your financier with a cogent explanation of the issues you are facing, the steps being taken to rectify those issues and the short and medium term financing needs of your business.

If you can show a clear pathway out of your cash flow crisis then you have a chance that the finance needed will be approved, as it is only a temporary requirement.

If you can’t show a pathway out then you face a credibility issue with your financier – the precursor to a collapse caused by overtrading.

The Key Message

The key message for business owners (and their advisers) wanting to avoid the trap of overtrading is to plan for growth upfront, to track performance against plan, adjusting and revising the plan as dictated by the real world experience.

Read More

It’s the Vibe (On Overtrading) – Part 2

It’s the Vibe (On Overtrading) – Part 2

My first post on this topic dealt with the consequences of overtrading and the difference between business growth and overtrading.

This post will help an owner of a small or medium-sized business identify when their business is overtrading.

I think there are a number of qualitative and quantitative signals that help a business owner identify when growth has become overtrading.

Here’s what I would be looking out for:

Qualitative Factors

  1. A feeling of being overwhelmed by the volume of orders on hand;
  2. Increasing volume of customer complaints, or customer complaints when previously there were none;
  3. Rapidly changing priorities;
  4. Lack of time to concentrate on other (staff training, financial, etc) aspects of the business.

Quantitative Factors

  1. Negative operating cash flow*;
  2. Rapid increase in net working assets#;
  3. Rapid lengthening of the Cash Conversion Cycle#;
  4. Rapid lengthening Debtor Days and Stock Days#;
  5. Extending Creditor Days# beyond agreed payment terms;
  6. Insufficient funds in the bank account to meet normal operating expenses.

* A quick way to measure Operating Cash Flow is to calculate the Net Profit after Tax for the period, less dividends paid in the period, plus depreciation expensed in the period less the increase / plus the decrease in Net Working Assets over the period.

# Follow the link to find out what these terms mean and how to use your financial information to measure and track them over time.

As the business owner generally works in the business I think it most likely that they will notice the qualitative factors first. As a business adviser often sees the business from a financial perspective I think it most likely that they will notice the quantitative factors first.

In isolation, I think of these factors as trip-wires. They alert the business owner to the danger that growth is becoming overtrading. So, whenever one of these wires is tripped, the business owner (or their adviser) should take a hard look at whether other signals are also present. For example, a business owner feeling overwhelmed by the volume of work should take a hard look at what is happening to the working capital of their business. Similarly, a business adviser seeing a trend of negative operating cash flow should ask the business owner about the volume of work, level of complaints, etc.

If only one type of factor is evident (ie: either qualitative or quantitative, but not both) then overtrading may not be an issue. However, I think overtrading is definitely occurring when both qualitative and quantitative factors are evident. 

So, here is the message for business owners (and their advisers): By knowing the difference between growth and overtrading, and the signals that help identify overtrading, a business owner (or their adviser) is in a position to take action to mitigate the damage caused by overtrading.

My next post, which will be the last on this topic, will look at some of the responses a business owner can take to remedy overtrading and return to growth.

Read More

KPIs for All SME Businesses

KPIs for All SME Businesses

The play, “A Man for All Seasons” tells the story of Sir Thomas More, the C16th Chancellor of England who refused to endorse Henry VIII’s wish to divorce his wife, Catherine of Aragon. More was a man of great integrity, who whilst pragmatically adapting to changing circumstances, remained true to his beliefs despite enormous pressure being brought to bear upon him.

This article will describe a set of KPIs for SMEs that behave in a similar fashion to Sir Thomas More. These KPIs offer the SME owner a succinct and relevant insight into their business under all conditions, irrespective of Industry, external factors or pressures. Being easily identified and measured they are pragmatic. They are the “Universal KPIs” I referred to in The Emperor’s New Clothes (About KPIs).

Those of you who have read some of my earlier articles may have guessed the identity of my Universal KPIs. I introduced them in The Magnificent Seven and built on that introduction with posts on interpreting financial information (Cracking the Code) and understanding working capital (Seeing the Light (On Working Capital)).

The table below sets out my Universal KPIs and depicts a hypothetical business story (click on the table to expand it):

KPI Table

This table shows Monthly and Year to Date outcomes for my Universal KPIs. The stories told by the table are summarised below, which I hope will help the reader appreciate the clarity of the insight provided by these KPIs.

The Monthly Story

Sales are $45k below budget. However, the above budget Gross Margin of 47% has reduced this cash drain to $9.65k. Operating Expenses (which exclude Interest Expense and Depreciation) are $10k lower than forecast. The net outcome is a small inflow of $350, relative to the budget expectations.

Debtor Days have shrunk to 60 from 62 in the prior month, but the average time taken to collect debtors remains slower than the budget expectation (55 days). Nevertheless, the 2 day reduction in debtor days compared to the prior month has brought $30.7k of cash into the business. Stock Days have shrunk to 95 from 97 in the prior month, but the average time taken to sell stock remains slower than the budget expectation (90 days). Nevertheless, the 2 day reduction in stock days, relative to the prior month, has brought $16.7k of cash into the business. Creditor Days have expanded to 40 days from 37 days in the prior month, and Creditors are now being paid 1 day slower than the budget expectation (39 days). In the current month, the 3 day expansion in Creditor Days has resulted in $25k being retained in the business. Shortening the Cash Conversion Cycle by 7 days during the month has brought $72.4k of cash into the business.

Capital Expenditure in the month was $10k, in line with budget.

In summary: The cash brought into the business from its earnings during the month was in line with budget, albeit the manner in which this was achieved was different from expectation. The actual cash used for capital expenditure purposes met budget. The vast majority of the $72.75k of cash brought into the business during the month is due to a shortening of the Cash Conversion Cycle relative to the prior month.

The Year to Date Story

Sales are $400k below budget. However, the above budget Gross Margin of 45.6% has reduced this cash drain to $146.4k. Operating Expenses are $50k below budget, further reducing the cash drain to $96.4k.

Debtor Days are averaging 60 days, slower than the budget expectation of 55 days, leading to a $16.4k outflow of cash from the business. Stock Days are averaging 95 days, slower than the budget expectation of 90 days. Nevertheless, despite the slower stock turnover there has been a $20.8k inflow of cash in the Year to Date, reflecting the lower business activity and higher gross margins. Creditor Days are averaging 40 days, slower than the 39 days forecast, resulting in $18.8k of cash being retained in the business. Although the Cash Conversion Cycle has expanded by 9 days from 106 days per the forecast to 115 days there has been a net cash inflow of $23.2k, due to a shrinkage in Sales and the higher Gross Margin.

Capital Expenditure on a Year to Date basis is $40k, a saving of $10k on the budget, resulting in that amount of cash being retained in the business.

In summary: The net outcome is that the business has $63.3k less cash than forecast. This outcome has mainly been driven by the lower Sales, which an improved Gross Margin, lower Operating Expenses, lower Capital Expenditure and a modest inflow of working capital funds (as a consequence of the shrinking business activity, not due to a shortening of the Cash Conversion Cycle) has not been sufficient to offset.

All of these factors can be influenced by an SME owner. Indeed, if the Cash Conversion Cycle had met the budget expectation the result would have been a $10k cash inflow into the business in the year to date, relative to expectations.

The Message for an SME Owner

 When I worked in banking, these seven factors were the major drivers of our financial forecasting software (there were a few others: depreciation rates, interest rates, tax rates, dividend rates etc).  They are used because of their close link to the “operational” cash flow of an SME business.

This in part explains why they make great KPIs for an SME. The other significant factor in their suitability as KPIs is that the SME owner can make decisions and take actions that impact on each of theses 7 factors, and hence directly impact the cash flow of their business.

I regard them as Universal because all SME businesses, regardless of Industry, are capable of measuring Sales, Gross Margin, Operating Expenses, Debtor Days, Stock Days (or for professional firms, its equivalent, Work In Progress Days), Creditor Days and Capital Expenditure.

So, if you own a small or medium-sized business and would like to know more about its financial and cash flow health then a good place to start is by tracking these 7 factors on a monthly and year to date basis.

Read More

Seeing the Light (on Working Capital)

Seeing the Light (on Working Capital)

When I was in my teens, a favourite movies was the Blues Brothers. It was shown at the (then) decrepit Cremorne Orpheum cinema in Sydney. We’d watch, dance and sing along to this movie with its absurd plot, revelling in its wonderful sound track.

If you are familiar with the movie, you will know that Jake and Elwood are on a mission from god, to raise the money needed to save the orphanage where they grew up. They don’t know how they are going to source the money until Jake “sees the light” and they decide to put the band back together.

This blog will help SME owners “see the light” on why managing working capital is an easy way to increase cash flow. It picks up on a key message from the research set out in my first blog (It’s Not Rocket Science, 19 November 2013) being that a business with a shorter cash conversion cycle (ie: one that manages its working capital) has better liquidity, requires lower levels of capital and enjoys better returns on investment than a firm that does not manage its working capital. It will give the SME owner the tools needed to begin managing working capital.

First, let’s define a few key terms.

The Cash Conversion Cycle is the number of days between the outlay of cash (to acquire inventory, for example) and the recovery of that cash (the collection of sale proceeds from debtors). It is calculated by adding Debtor Days to Inventory Days and then deducting Creditor Days from this figure.

Debtor Days is a measure of the number of days it takes to collect debtors. It is calculated by dividing Trade Debtors at a point in time by the aggregate of Sales for the 12 months to that point in time and multiplying that result by 365.

Inventory Days is a measure of the number of days a business holds its stock before it is sold. It is calculated by dividing Stock at a point in time by the aggregate of Cost of Goods Sold for the 12 months to that point in time and multiplying that result by 365.

Creditor Days is a measure of the number of days it takes a business to pay its trade creditors. It is calculated by dividing Trade Creditors at a point in time by the aggregate of Cost of Goods Sold for the 12 months to that point in time and multiplying that result by 365.

The Capital of a business is the sum of the equity provided by the owners of a business plus the debt a business has raised from its financiers.

The Working Capital of a business is the amount of Capital invested in the Net Working Assets of the business.

The Net Working Assets of a business are its Inventory plus Trade Debtors less Trade Creditors.

To manage Working Capital an SME owner first needs to measure and track the value of the Net Working Assets and Cash Conversion Cycle.

Net Working Assets represent a Point in Time view of Working Capital. An SME owner who tracks the value of their Net Working Assets on a monthly basis will know the amount of Capital invested as Working Capital and whether that investment is rising (using cash) or falling (generating cash). By breaking the Net Working Assets into its constituent parts, the SME owner can establish the driver(s) for the movement in their Working Capital.

The Cash Conversion Cycle is a Relative view of Working Capital, which provides the SME owner with information about how their Net Working Assets are moving relative to the trading of the business. By tracking the Cash Conversion Cycle over time a business owner will receive information about how efficiently their business is using its available Capital – a falling Cash Conversion Cycle is a sign that capital use is becoming more efficient (ie: you’re stretching a dollar of capital further), a rising Cash Conversion Cycle is a sign that capital use is becoming less efficient (ie: you’re likely to run out of capital sooner).

This information is useful to all SME owners, in all business situations. It is essential for an SME owner with a growing business as nothing uses Capital quicker than growth.

Working Capital management begins when an SME owner uses the information from tracking Net Working Assets and Cash Conversion Cycle to identify and prioritise for review those operational elements of their business that impact on Net Working Assets. For example, the invoicing process, customer credit policy, and debtor collection process have an impact on the value of Debtors and on the Debtor Days ratio – by reviewing these processes it may be possible to reduce the value of debtors / speed up their collection without compromising Sales. Similarly, stock re-order triggers, minimum and maximum holdings, identifying fast and slow-moving stock, and supplier delivery times have an impact on the value of Stock and the Stock Days ratio – by reviewing these processes it may be possible to reduce the investment in stock / reduce its holding period without compromising Sales.

Process improvement can be measured by tracking subsequent changes to Net Working Assets and Cash Conversion Cycle. Using this approach, continuous improvement and low risk, incremental changes to working capital related process is possible. If done successfully, the SME owner will see a permanent reduction in the use of their Overdraft, or a permanent increase of funds in their Bank account.

The SME owner who has “seen the light” has options in the form of access to greater cash flow: they can use this cash flow to invest in the continued growth of their business, to pay a dividend, or increase the efficiency of their business. If you’re not already actively managing your working capital it is time to jump on the band wagon.

Read More