Can your business finance its rebuilding as we emerge from the long era of COVID-19 lockdowns?
As we finally move out of this prolonged period of lockdowns and border closures, many businesses that have experienced a fall in revenues will be able to start rebuilding their businesses back to pre-coronavirus levels. But how many of these businesses are fully aware of the “cash trap” they are facing? And how many have a plan for financing their businesses as they try to overcome this “cash trap”?
The sad and ironic reality is that many businesses will have survived the two years of lockdowns and border closures, only to collapse as they get back to “normal” business conditions. This article provides a clear pathway for enabling your business to negotiate its way out of this high-risk period.
This article looks at:
- The hidden cash trap – the threat to your cash reserves?
- What are your financing needs?
- What are your financing options?
- How will you manage your cash?
The Hidden Cash Trap
In many circumstances It can be easier to manage cash during a period business decline than it is to manage cash during a period of growth. During a period of decline the working capital needs of the business are likely to fall. This releases cash from working capital into the trading accounts of the business. The business is likely to be reducing costs during this period as well so as not to use up cash reserves that provide a buffer for the ongoing needs of the business.
Rebuilding your working capital investment
Many established businesses have spent years building the investment in their working capital. Some of this time would have been painful as the business was forced to reinvest profits into their growing working capital investment.
So, what is the “cash trap”? At a basic level, working capital is represented by debtors, inventory, and creditors. An example of how a period of decline followed by a period growth creates a cash trap is shown below
Period prior to decline
- Debtors $800,000
- Inventory $450,000
- Creditors $250,000
Investment in working capital $1,000,000
Period after decline
- Debtors $400,000
- Inventory $250,000
- Creditors $150,000
Investment in working capital $500,000
This shows that the period of decline reduced the investment in working capital by $500,000. This figure represents cash that has been returned to the bank account of the business. This would have happened over a prolonged period of time and the source of this cash may not have been recognised by the business managers..
The “cash trap” is partly driven by the fact that, as the business returns to pre-COVID levels, it will need $500,000 of additional funds to re-finance its working capital needs.
Things can be a little more complex. We would expect that there will be higher levels of slow paying debtors and bad debts because many of the debtors sitting in the receivables ledger of these businesses are experiencing similar “cash trap” exposures. The rebuild could also be made more complex as suppliers of goods and services experience capacity issues and you find that you need to source from other suppliers where pricing and quality are not fully assured.
As business conditions worsened, many businesses would have reduced their investment in capacity. This includes letting staff go, selling equipment and motor vehicles, and cancelling subscriptions, insurance cover, and a range of other costs. As the business starts to return to previous business levels, it will need to reinvest in capacity to enable it to deliver the goods or services at the previous levels.
Many established businesses have spent years building the investment in their working capital.
Resourcing the increased personnel needs will include the costs of recruitment, induction, and training. On top of the measurable costs, the hidden costs are lower productivity from the new personnel and lower productivity from the teams around them as they support the development of the new team members.
The other costs involved in rebuilding capacity will vary with the type of business, but they will be there. This will include a range of costs such as recommissioning production lines, purchasing new warehouse equipment, scaling-up sales, and operations planning processes.
Returning to previous profitability levels
The costs involved in getting back to the earlier profit levels will be further added to by a range of other factors. A range of overhead costs will increase ahead of the return to profitability. This will be a one-off impact on cash, but it is real and will demand funds from the business. An example of where this could be significant is sales and marketing. Businesses with interstate or international customers who they have not been able to visit regularly over the recent period may need to intensify interstate or international travel. Promotional campaigns may be ramped up to guard against losing market share as demand returns.
What are your financing needs?
Understanding what your financing needs are and what the business is actually financing is an important consideration. This article will summarise the approach for understanding this on an ongoing basis in the last section. In essence, the business will need to finance the following areas.
As described earlier in this article, the business will most likely need to fund the increased level of working capital. It is important to know what level of finance is going to be needed to cover this. The investment in working capital may continue to increase over a period of time. Working capital finance facilities can be arranged to cover the increases and falls in this area.
Investment in equipment and other productive fixed assets is generally easier to finance through asset finance products. Understanding the financing need in relation to the capital investment is much more straight forward. However, the business needs to understand the useful life of the capital equipment and be clear that financing products have appropriate terms and that any balloon payments at the end of loan periods are not excessive in relation to the likely resale value of the equipment at that time.
Other business costs
Other costs involved in growing the business are more difficult to finance. This might include funding the business through a period of losses before it returns to profitability, or the costs involved in restructuring or relocating business operations. This is more appropriately financed by equity. Debt finance can be an option although this is likely to require additional security.
Some businesses may also want to finance acquisitions during the growth period. A business acquisition will include some tangible assets (eg: plant and equipment, inventory, etc) and some intangible assets (eg: goodwill). This could be funded via a range of finance options matched to the different components of the acquisition.