Too many new and not-so-new SMEs losing touch with reality
Post COVID evidence is piling up that government financial aid and legal concessions during the pandemic, together with an era of close to zero interest rates, have caused many operators of both start-ups and not-so-new SMEs to lose touch with the reality of sustaining a sound business.
Which is why Macks Advisory now offers business owners a reminder of some fundamentals.
Traditionally about 33% of Australian start-ups fail within four years, but now almost half of them (48%) go belly up within that time, and 25% don’t even last 12 months.
As for small businesses established more than four years ago, many that had tended to struggle at the onset of COVID-19, were flourishing when it ended. This was often because operators had got used to having cash flow difficulties (not necessarily pandemically caused) eliminated by government aid that masked their incompetence.
In short, many directors who back then lost touch with reality, still haven’t regained touch – and here is why.
Clouding a path to success
Inability to maintain cash flow is common to most failed businesses because owners believe in myths that can cloud a pathway to success.
For instance, it’s Macks Advisory’s experience that many business owners, especially owners of small businesses, believe they should always hold a lot of stock for fear of not being able to instantly meet customers’ requirements.
Thus, these owners, in perpetuating the myth that a big inventory is an important factor in business success, tend to tie up a significant percentage of working capital that can’t be freed until stocked items for which demand has deteriorated can be sold. Efficient businesses don’t harbour unused capital.
For example, we’re aware of a supplier of toiletries to a major supermarket who had built the business to a stage where he felt he needed to have on hand substantial stocks of product – which wasn’t a problem until the supermarket closed with three months’ warning and left him with way too much inventory that was in effect dead capital – until the stock was eventually sold elsewhere at a loss.
Businesses of all sizes should keep in mind Toyota, which pioneered what’s become known as a “just-in-time” strategy where stock levels are organised to correspond to demand levels at specific times of year and in forecast circumstances.
SMEs can use the same strategy seasonally to lessen chances of being over-stocked during certain months of a year.
Supplier payment issues
Then there’s the persistent myth that slowing supplier payments to maintain cash flow is a good business strategy.
Countless business owners believe that when expenses of running a business are constant, but sales have slowed, common sense dictates extending supplier terms will boost cash flow and accordingly help maximise use of working capital.
Yet that’s a rash assumption that could seriously damage these owners’ reputations and subsequently their businesses. Frustration is inevitably generated among suppliers being paid weeks, sometimes months after issuing invoices, and this angst can manifest itself in ways none of which is good for owners or their businesses.
An effective way of dealing with this issue is for SMEs to have invoices financed, thus enabling suppliers to be paid within normal terms or even earlier (to get discounts among other benefits). In other words, it’s possible to use invoice financing to pay suppliers’ debts in 30 days and lenders later, perhaps within 60 or 90 days.
Business owners can decide whether the interest rate they pay to do this is worthwhile to keep suppliers happy and engaged, whether instead of delaying payments it’s better to transfer extended terms to a financier thereby avoiding supply chain disruption while also getting benefits from suppliers for prompt or early payment.
Profit and cash flow confusion
Meanwhile don’t confuse profit with cash flow. A business that can produce a good profit and loss statement doesn’t necessarily have a good cash flow. Profitability doesn’t guarantee cash flow is positive.
A business’s true cash flow situation can only be appreciated by constant forecasting and monitoring that will keep an owner in touch with the business’s most vital numbers. However, loans to release working capital and improve cash flow should never be regarded as a fix-all for a business struggling to pay its bills.
Before resorting to invoice financing, that is at best a band aid solution for survival, seek root causes of restricted cash flow. Can the business’s payment terms be favourably renegotiated? Should its customers’ payment terms be reviewed? (They may be willing to pay early given incentive.) Consider how best to increase cash flow by focusing on that 20% of the business’s best customers who traditionally account for 80% of its income.
Considering an end game
Current research indicates only 19% of SMEs have an exit strategy. If only one in five business owners have a plan for quitting their business, then four out of five don’t have one, including many that have made the most of growth opportunities by way of debt and/or equity.
Yet founders may eventually want to retire having ensured their businesses are functioning sustainably, having taken care they’re not alone in retaining critical knowledge for that sustainability, and having otherwise set up their businesses to achieve a top price for sale at an ideal time.
They may well want to make their departure in ways that provide them, perhaps also family members or colleagues, with desired financial outcomes.
Alternatively, owners who have nobody to whom they want to pass on their businesses but are also interested in seeing them prosper, can achieve this by using capital acquired by partial sale to third parties they equip with critical knowledge to ensure continuous, unhindered function of these companies. Such owners can thus extract capital they initially invested in a business to fund retirement, while also maintaining a financial interest in it.
A business owner seeking a quick exit could of course simply sell the business, set up a merger or arrange a stock exchange listing.
Nevertheless, all the groundwork necessarily done for any of the above things to happen will likely come to nought if there’s no succession plan. Procrastination in this matter can result in a wide range of catastrophic scenarios.
