Restructuring, cash flow, and working capital can be a very confusing aspect of doing business, and it’s normal to feel overwhelmed. Josh was joined by Andrew Weatherley from WCT Advisory about these important business factors, and more.
Andrew has extensive experience in all aspects of personal and corporate insolvency and advisory in Australia. With over 18 years of experience gained working in two of Australia’s foremost corporate restructuring and advisory firms, Andrew is an expert on business restructuring.
What Is a Working Capital Ratio?
Working capital is based on assets that can be converted into cash quickly, such as cash in the bank, debtors, and stock. These assets are used to pay off liabilities, and they are essential to a business’s survival. Lack of working capital and cash flow issues are among the top reasons why businesses fail. It’s a simple concept, where cash and assets are converted to cash because it’s cash out the door. Profit on financial statements is irrelevant if liabilities remain unpaid. When giving advice and recommendations in the restructuring space, understanding a business’s cash flow is crucial.
Preparing a Cash Flow Forecast
Having enough cash to cover the costs of a particular process is crucial to ensuring the underlying viability of a business. To achieve this, the first step is to prepare a cash flow forecast, which I think every business should have. At WCT, we prepare it on a monthly basis, and also check in every couple of weeks to track progress. We look at the funds expected to come in, and analyse whether they have come in or if there has been a shift. Businesses should be aware of liabilities, such as superannuation GST liability and PAYG liability, and build cash prior to that month to ensure they can pay those things. However, there is a point where a business can have too much working capital.
How Much Working Capital Is Too Much?
There is a limit to how much working capital a business should have, and different people may have different views on what that limit is. However, in my experience working in the restructuring and insolvency space, it is rare to see a business with too much working capital. Calculating a working capital ratio is important as it indicates whether a business is deploying its cash well and whether it will have issues paying its liabilities. A ratio of one or above means that a business has sufficient cash or current assets that can be turned into cash quickly to pay its liabilities at that point in time.
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Converting Assets to Cash
Assets that can be turned into cash quickly are things such as such as stock, debtors, and cash in the bank. Businesses need to convert their stock into cash quickly to ensure that they have sufficient cash flow. One way to do this is by turning obsolete stock into discount sales to generate cash. Debtors can be a major issue for businesses as they may not pay their bills on time, causing cash flow problems. It’s extremely important to follow up with debtors and collect payments on time to ensure the smooth operation of a business.
Follow Up on Your Invoices
One of the biggest issues in businesses is their debtors, which are customers who owe them money for a product or service. Often, businesses don’t handle the process of collecting debts very well. For example, they may issue an invoice with 14-day payment terms and then not follow up until 28 or 30 days have passed. This delay can create cash flow problems for the business, as the payment is needed to pay for liabilities, rent, and employees.
I know of a business with a customer who owes them close to $400,000, and I have no idea why the business let it get to that point. The business had been issuing invoices for months, but after the first, second, and third invoices weren’t paid, they continued to issue more without any follow-up. This situation could potentially lead to insolvency and the loss of the entire $400,000. Large companies often manage their accounts receivable well and partner with industry groups for support and training. Properly managing the collection process is important to ensure cash flow and the ability to pay liabilities.
Analyse Your Working Capital
Analysing working capital and cash flow is crucial for businesses. Many companies fail because they grow too quickly and do not have enough working capital to support their expansion. For instance, in the construction industry, businesses may acquire equipment and hire employees to fulfil a contract, which requires a significant investment upfront. However, payment for the project is not received until a later date, leaving the company carrying substantial costs for several months. In this situation, having enough cash flow and working capital is critical to avoid failure. If a business cannot manage its expenses during this period, it may not pay superannuation, ATO, or BAS, which could cause things to go terribly wrong. Therefore, it is essential to have a plan to manage expenses and obtain funding if necessary.
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Restructuring and Mitigating Risks
Restructuring and mitigating risks in businesses can be done by being aware of the finance side of the business. This involves partnering with the right accountant or bookkeeper who can provide advice on managing cash flow and working capital. A group of people, including the accountant and director, should meet regularly to discuss the business’s financial situation and plan for any upcoming contracts or projects. It’s also important to have a cash flow forecast to identify any potential cash flow problems before they occur.
If a business does find itself in financial trouble, it may need to seek finance from secondary or private lenders, which may have higher interest rates and stricter conditions. I know of a demolition company that entered voluntary administration and a Deed of Company Arrangement to deal with its debt. The company negotiated with the administrator to provide some working capital to last them until they were paid for their jobs, and they also looked into debtor financing to generate cash flow.
When a business faces insolvency, it may need to seek private funding or alternative lenders, as big banks typically won’t consider financing. I believe you should focus on restructuring the business to make it profitable, so that in the future it may be possible to secure better financing options with lower interest rates. Ultimately, having cash flow and funds is essential for businesses to navigate difficult periods and come out stronger on the other side.
How to Find Relevant Resources
I recommend looking online for resources on improving cash flow, as there is a lot of helpful information available. Searching “ten ways to improve cash flow” to find common strategies, such as managing cash on hand, collections, stock turnover, and creditor and supplier management will bring you a lot of great results. If you are facing issues with your business, I can’t undersell the importance of having open discussions with landlords and other stakeholders to manage any potential issues or challenges that may arise.
If I know we’re going to be a little tight and I’ve got an accounting invoice, I’ll talk to my accountant and say, look, I know the invoice is due here, but I’m just going to need an extra couple of weeks. It’s about balancing your inflows and your outflows and doing that the best you can.
Have the peace of mind that your systems are running smoothly while you focus on growing your business.
One strategy to improve cash inflows is to offer early payment discounts. Managing outflows is important and make sure to have discussions with creditors and suppliers to manage payments. While some expenses, such as wages, must be paid on time, others can be stretched out as long as there is communication and notice given. Always remember to meet payment obligations to maintain good relationships with suppliers and creditors.
What Business Built Freedom Means to Me
Business freedom to me is the ability to undertake what you want to do. When you set up a business, you’re doing it for a reason. There are several reasons why you might, but that sort of business freedom is being able to achieve those dreams.