Steven Tindale
January 30, 2023
Welcome to part 4, the final part of our Surviving or Thriving thought series. In this brief case study we look at the cash flow crunch – what it is, how it can occur, and tactics we implemented to ensure our client could get well positioned to avoid a potential crunch.
Did you miss the first three articles in our series? You can find them here: part one | part two | part three
What is a cash flow crunch?
A cash flow crunch is a situation in which a company or individual has difficulty meeting their financial obligations as they come due, because they do not have enough cash on hand. This can happen for a variety of reasons, such as a decline in sales, unexpected expenses, a lack of access to credit, or even just timings of outgoings or poor payment terms. Businesses that at face value appear to be generating strong sales can still be at risk of a cash flow crunch.
A cash flow crunch can be a serious problem, as it can lead to default on loans, difficulty paying bills, and even bankruptcy. To avoid a cash flow crunch, companies and individuals often create cash flow projections, as well as taking a range of steps to manage their cash flow more effectively.
Case study background
Our Business Advisory team recently advised a new client experiencing large fluctuations in sales, profits and as a result, cash flow, whilst trying to grow and expand their presence across Australia. The business supplies goods, and is required to carry large stock holdings and significant credit accounts. Unexpected events also caused damage to stock and premises, impacting the ability to trade for a period of two months.
The owners wanted advice on how to improve their profit, better manage cash flow and minimise loss of income from future unplanned events.
This case study highlights the importance of business owners understanding the true cost of running their business and factors influencing their profit and cash flow. It also provides guidance on how to structure funding arrangements for unique business circumstances and how to use insurance as a means of protecting business income.
Client issues
- Unsure of breakeven sales level
- Not understanding the benefits of profit ratio analysis and budgeting
- Not enough working capital
- Inadequate business insurance
How we resolved the cashflow crunch
For this client, the first step was a range of detailed analysis to understand the current financial situation of the business, and determine key profit and operating ratios. Once this was completed, we could then assist with recommending and implementing a range of strategies to improve cashflow. The four areas we focused on were breakeven sales, improving profitability, working capital management, and funding options.
1. Breakeven sales
Problem: Unsure of breakeven sales level
A breakeven sales level is important because it represents the point at which a business's revenues and costs are equal. It helps the company determine the minimum level of sales necessary to cover all of its costs, including fixed costs such as rent and salaries, and variable costs such as materials and labour. Knowing the breakeven point helps a business make better decisions about pricing, production, and marketing, as well as identify when it needs to increase sales in order to become profitable.
Solution: A detailed review of the sales mix, profit margins and annual outgoings was completed to pinpoint the minimum monthly sales required for breakeven.
2. Profit ratio analysis
Problem: Not understanding the benefits of profit ratio analysis and budgeting
Undertaking and understanding financial ratio analysis has wide range of benefits for businesses. In the case if this particular client, ratio analysis has provided:
1. A benchmarking tool: Ratios can be used to compare a company's performance to that of other companies in the same industry or to industry averages, which can help identify areas where the company is excelling or underperforming. Once ratios are determined, we can provide a comprehensive SME Benchmark analysis as part of our Business Advisory Services.
2. Identification of liquidity risks: Financial ratios can assist with identifying low liquidity - a key red flag for a cash flow crunch.
3. Informed decision making: Ratio analysis can provide valuable information for decision-making, such as determining the best pricing strategy or identifying potential investments. By analyzing ratios, management can also identify areas that need improvement and take corrective action to improve the company's financial performance.
Solution: To better manage stock, a series of key profit ratio calculations were completed, and an upgrade of the stock management system was scheduled to improve margins and reduce wastage.
3. Working Capital Management
Problem: Not enough working capital
Prudent working capital management is important for a business because it helps ensure that the company has sufficient resources to meet its short-term obligations and maintain ongoing operations. It helps maintain liquidity, improve cash flow, increase efficiency, enhance profitability and improve creditworthiness.
Solution: To improve cash flow, a series of key cash flow ratio calculations were completed, and monthly cash flow budget was prepared to determine funding requirements (including timing). Customer payment terms were reviewed, and credit terms were re-negotiated with key suppliers.
4. Growth, Funding and Protection
Problem: Inadequate business insurances
For any business looking to expand, and protect income, the correct type of business insurance is critical. A business can use insurance as a means of protecting income by purchasing policies that provide coverage in the event of a loss or interruption. For example, a business might purchase property insurance to protect against damage to its physical assets, liability insurance to protect against legal claims, and business interruption insurance to protect against loss of income due to a covered event such as a natural disaster or pandemic. Additionally, key person insurance can be used to protect a business from loss of income due to the death or disability of a key employee.
Solution: in the case of this client, funding options (both capital and debt) for growth opportunities were analysed and business insurances were reviewed and updated.
Moving forwards
By working closely with our Business Advisory team, our client was able build a strong baseline analysis from which to work from. This informed a targeted range of financial tactics targeted at improving the cash position of the business, and greatly reducing the likelihood of a cashflow crunch. Not only did we assist our client with tactical implementation, we also upskilled their financial acumen, better placing them to understand and manage the business as it moved into a new national stage of growth.
Understanding the local market is one thing, understanding the national market is another. The financial ratios we established were then used in our SME benchmarking process to assist the client with understanding how, and where they would need to perform in comparison to national competitors to ensure their expansion would be a success.
Are you up against a cashflow crunch?
Contact our Business Advisory team today: businessadvisory@dfkgpca.com.au / (08) 9327 1777