Most directors of failed businesses cite a drop in profitability caused by tougher trading conditions as the main reason for their firm's demise. In reality for many of these businesses, it is not 'profitability' but 'cash flow' which was the real problem. A drop in profitability can often be weathered with a strong cash flow management system in place.
Ipsos Mori recently undertook a quantitative study of MD's of a cross-section of SMEs around the UK, defining SMEs as having an annual turnover of between £250,000 and £25 million. It also undertook a qualitative study of those firms that took successful and innovative action to anticipate or resolve cash flow problems arising from the national economic downturn.
Although the government is predicting the country will start to emerge from the recession later this year, most private sector economists believe that the recession will last into 2010 with a slow and weak recovery when it does happen. The latest news that the UK economy contracted by a further 0.8 per cent during the second quarter of the year lends weight to the view that recovery is still some way off.
Of the business leaders surveyed, 30% have seen significant market declines, 32% have seen some market slow-down, 36% say their market is stable or even showing some growth, with the remaining 2% uncertain.
The most adversely affected aspect of their businesses was cash flow, with 61% of respondents reporting a downturn in their cash position.
Actions taken by those firms that had not been hit by the recession include:
Cutting prices (42%)
Reducing staff numbers (30%)
Reducing working hours (18%)
Cutting salaries (18%)
Of those businesses hard hit by the recession, just three percent say they were forced to sell part or all of their business and 5% were forced to close down part or all of their business
Nearly two thirds of all businesses say that they have introduced at least one measure to combat the added pressure on their cash flow, and most of these have been defensive measures that include:
More active debt chasing;
Asking for a higher proportion of payment up front;
Increasing the use of credit checking; general cost-cutting (process, people or cost of materials).
Interestingly, several companies had reported success by going on the offensive, taking opportunities to market more aggressively, whether by cutting costs or buying up competitors - resulting in an increase in market share.
Financial strategies are also used by 60% of companies in their formal cash flow procedures. Multiple bank accounts are one of the most common methods used ie. putting funds onto the money market and using fixed rate term deposit accounts.
Although instruments like asset finance, leasing, factoring, invoice discounting were not used by many interviewees, those that did use them said they made a very significant and positive difference to their cash positions.
A quarter of respondents had a formal financial risk management strategy in place, these tended to be larger organisations. The most common strategy was managing their loan interest either by fixing over a period or by the use of 'caps and collars' - which, although simple, are known to less than half of all respondents. Exchange rate hedging was also used by some of the large firms, but overall only 35% said they understood how hedging works. Doubts about the effectiveness of financial risk-mitigating devices are often dispelled once they are explained and successfully demonstrated.
The importance of having a stringent cash flow management system in place for anyone considering selling their business in the near or medium term can't be stressed enough. Buyers are going to be looking very hard at whether prospective acquisition targets can show profitability during economic troughs, and for many businesses, profitability depends upon cash flow.
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