9.1 Know Your Options in a Crisis
You're facing a financial hurdle - what next?
If you are facing a financial crisis, the first thing to do is not panic.
Next, you need to make a rational assessment of the various options available to you. Borrowing can help a business during difficult times and can help a business grow during good times. But it is critical to review financing options:
Compare the cost of each:
- Bank overdrafts or loans. The cost of borrowing money from a bank isn't prohibitive. Banks today will certainly lend against a good strong order book. Figure out what it will cost to borrow from your bank.
- Sales financing and factoring provide methods of getting cash into the business. These options enable you to buy a product, pay for it within 30 days. The bank will then pay you 80-85% of your debtor book. This means you can sell the product and pay 80% of that sale in the next day, rather than having to wait for the customer to pay. The bank then takes the burden of collecting the money from the customer. This is called factoring. If you shoulder the burden of collecting the money yourself, the bank becomes a sales financing vehicle. Ask your bank what sales financing will cost you or factoring will cost you
- Early invoice discounting. This involves having arrangements with your customers to incentivise them to pay you earlier than usual. They receive an incremental discount while you generate cash. In this day and age, especially on commodity products, incentivising by 2 or 3% is very attractive to companies that don't have financial worries. Figure out what discounting early payers will cost you over a given period
- Extended credit terms. Paying interest or a premium in order to extend credit terms is a viable method of leaving more cash in the business over a given period. Figure out what the necessary interest or premium will cost you over time.
Match the cost of each financing option to each other. Which option is the most cost-effective?
Review:
- The cost of borrowing from the bank
- The leverage and level of debt: ie ? how much you've taken on as debt and your ability to repay.
An entrepreneur's borrowing ability is based around their ability to repay the interest against that loan. That's what's critical. If profits generated more than cover the interest payments (by at least two to three times) a medium term debt funding option will be preferable than taking extended credit or giving larger discounts. Weigh up the costs of each financing option to see which is the most viable for your business and cash flow situation.
9.2 Strengthen cash flow from the outset
Putting financial affairs in order
Managing your cash in a focused manner is fundamental to survival, let alone success. Businesses are more likely to fail because they run out of cash - not because they're unable to generate a profit. You can have a lorry load of orders with the promise of untold profits in the pipeline, but if you don't have the cash to make and sell your products in the first place, and you are unable to pay your immediate bills, your business will fold.
Cash flow is a common hurdle for small and start-up enterprises. For that reason, it important to strengthen cash flow from the outset.
- Monitor profit and avoid over-commitment. One common mistake entrepreneurs make is that they see a run rate of business and immediately start to incur costs. They'll rent an office, take on new lease commitments, buy a new car. These monthly payments can result in losing sight of the real cash that's generated through the business. Monitoring profit against commitments is a key component of managing cash flow. It is far better to take out a medium to long term loan at a low rate in the early stages, than over-finance the business by taking on big commitments.
- Grow the business organically and keep costs down, especially if you can't access bank finance. Focus on keeping costs to a bare minimum. Forget the office; work from home. Forget the car; use public transport. Grow the business, grow a pot of cash and then invest in the business. Using that money to reinvest is vital.
- Build relationshipsand trust with suppliers. In business there are situations when you have to commit to buying more stock or commit more of your time. In order to reduce the risk of over-committing, it's vital to build strong relationships with your suppliers. That way, your suppliers get to see your focus and return on that investment and they are more likely to support and trust you.
- Align yourself with a key supplier and devote more time to selling their product set.
- Ask for extended terms early on. Don't say, ''by the way, I can't pay you for another three weeks.'' Getting a bad reputation for payment is a disaster. Getting a reputation for being open and honest from the start is far better.
- Offer to pay a slightly bigger premium in exchange for extended terms to spread payments over a given period. Being open and working out that cash flow model from the outset is vital.
- Reinvest profits wisely
- Understand what your start up and ongoing costs are. Be realistic. It is better to overestimate expenditure and time and underestimate revenue than fall short of revenue and overspend.
- Evaluate and monitor profit continually.
- Reinvest your profit. That way, you''ll scale the business far quicker, than if you use the profit to rent another office building or buy a car. It's how you spend the profit that's important. Entrepreneurs always spend profit on the business. Successful entrepreneurs invest that profit on the right areas to maximise growth and enhance existing offerings.
Profitable businesses can still go under if they run out of cash at a critical moment. Forecasting is the most focused method of avoiding that obstacle.
- Forecast all costs and profits. Focus on daily cash flow. Being aware of start up costs, how long it will take from first customer contact to first payment; estimating time, equipment, packaging, tax and staff costs is the first challenge. Knowing how much you need to earn in order to cover all outgoings, including overheads, salaries, stock, materials and capital expenditure; plus how much you need to break even and turn a profit is the second challenge. But it is the flow of money, the balance of cash that flows in and out of a business on a daily basis, along with the way in which profit is invested, that can make or break a business.
9.3 | Reality check: averting disaster
- Have you committed only to what you can afford? Are you avoiding over-financing the business?
- Are you monitoring profits against those commitments?
- Are you keeping costs to a bare minimum if growing organically?
- Are you reinvesting profits effectively? For example, when experiencing a run rate of business or a seasonal upsurge are you focusing on keeping costs down and absorbing the profits so you can reinvest without over-stretching the business in less profitable periods? Or are you incurring new staff or premises costs and scaling growth because you have guaranteed income secured (via a contract)?
- Have you focused on building relationships with bankers and suppliers?
- Have you reviewed each financing option available to find out which is the most relevant and cost-effective to use?
- Have you reviewed the cost of bank borrowing and the leverage you have (your debts and your ability to repay them?)
- Are you aware what is coming in and going out of the business in terms of cash on a daily basis? Have you effective forecasting tools in place?
- Are you focusing on lead generation and closing sales?
- Have you increased your prices, reduced costs and increased sales targets?