"Breaking bad habits"

A lack of cash or financial expertise could see you using short-term facilities – such as an overdraft – to fund your long-term growth. This is a habit you need to break, because this approach is fraught with risk and typically indicates poor financial management or a lack of assets to support long-term debt financing.

Businesses that are over-trading typically fund growth by using short-term capital such as overdrafts which often have low credit limits, further constraining growth. The key point is that you need to choose the right form of capital to power that growth.

What are the key indicators?

The following financial indicators can help you identify if your business is using short-term capital to fund its long-term growth:

1. Regular overdraft usage and/or lack of cash.
2. Rising trade creditors or increasing creditor days.
3. Over reliance on factoring, that is, using invoice discounting facilities as opposed to long term debt, or the absence of structured finance in the balance sheet.
4. Deferring supplier payments and increasing creditor days.
5. Late debtor receipts and not managing debtor days.
6. Growth in overheads, particularly increasing fixed overheads which are difficult to manage in a downturn.

When faced with these indicators, it is vital that your key functions work collaboratively together.

Managing Director / CEO

The Managing Director / CEO needs to take control of the emerging situation by understanding the risks of funding long-term growth as opposed to using short-term facilities.

Time is well spent forming stronger banking relationships which are supportive of the business over the long term. It is also time to consider more than one provider of finance through, for example, multi-banking and securing finance from different sources to mitigate risk.

Finance Director

The Finance Director needs to take responsibility for identifying internal and external solutions to protect cash flow by providing detailed forecasts of trading activity and accurate assessment of the order pipeline. The FD should work closer with Sales/Operations to understand the macro-environment and flexing the forecasts based on different trading scenarios.

The FD should also spend their time negotiating better creditor terms and focusing on timely debtor collection, review pricing policies, regularly reviewing bank and alternative funding solutions as well as managing stock levels and ensuring the efficiency of stock control.

"Regular comms with the FD on any production issues, pricing and capacity is time well spent."

‍

Sales and Operations

The Sales and Operations teams need to support the MD and FD by reinforcing contractual terms with clients and regularly communicating with finance to optimise cash collection such as milestone payments. A priority for the sale and ops function is ensuring that the business has sufficient working capital facilities before entering into new contracts. Bringing invoicing forward on milestone payments to assist working capital pressures can help improve the situation.

Communication is critical and maintaining regular comms with the FD on any production issues, pricing and capacity is time well spent. It is also important to ensure that there are no manufacturing or production bottlenecks which might hamper sales by preventing finished products being delivered at the right time. And it may be necessary to ensure the sale proposition remains relevant and competitive in the market.

I often see owner-managers using overdrafts or short-term funding to fund long-term projects or having just one provider for their financing needs. This is a risky game to play especially if you consider the consequences of the finance partner going out of business or lack lending appetite.

Unfortunately, many SMEs lack enough experience in funding decisions to make the right financing decisions. My advice to any owner-manager is to form relationships with multiple financing sources that are supportive of your business and its goals. This approach will help you mitigate risk to ensure the long-term viability of the business you have grown.

‍

Key points

Here are my key points to keep in mind to avoid the pitfalls of this type of cash flow problem:

1. Always ensure that there is an appropriate balance between long and short-term funding to support your business and its growth.
2. Validate what security, such as personal guarantees, your business is prepared to provide to obtain facilities.
3. Minimise any financing costs.
4. Ensure that your business is not over leveraged and manage your balance sheet to prevent a lack of capital that could put pressure on your business and its growth ambitions.

I hope this article has provided some useful tips on what may trigger a cash flow problem caused when short-term capital is used to fund growth and how your teams should work together to mitigate any long-term damage.

We work with growing UK SMEs and small-cap PLCs that have funding needs in excess of £2m and regularly approaching £100m. Our clients’ needs will typically be for sophisticated finance products such as cash flow based lending or private equity investments. Our value lies in helping clients access funding that relies on confidence in future trading and cash flows. For a confidential, independent, no obligation discussion on the funding options available click the 'Let's chat' button.