Cash Management
By Mick McLoughlin
Keeping a tight grasp on the basics of cash management can
make the difference between corporate success and failure.
In a rapidly changing marketplace, today’s corporate
success stories can easily become tomorrow’s casualties.
Globalisation requires businesses, their stakeholders and
their advisers to operate in unfamiliar circumstances with
few precedents. At the same time, the need for companies to
evolve is resulting in ever more complex financing packages,
while the supplier base of finance providers is fragmenting.
One of the more underrated tools available to managers in
this tough trading environment is systematic and strong cash
management. More and more investors, analysts and rating agencies
are treating “free cash flow” as a key indicator
of corporate health. All businesses can benefit from a regular,
systematic review of their liquidity.
One of the most popular strategies for making the most of
cash flow – even for companies with access to the equity
markets – is internal restructuring to free up cash
and debt. Even of you are borrowing to pay for new plant or
an expanded workforce, it could also make sense to restructure
business units or streamline transactional procedures at the
same time to improve your firm’s capacity for cash generation.
Raising debt will simply treat the problem, whereas strong
cash management is a preventive measure.
In practice, the benefits that you gain from a restructuring
programme often have a direct correlation to inherent risk.
According to Ann Davies, head of operational restructuring
at KPMG, UK, business have a range of options, from “low-risk
quick wins through to long-term strategies that are often
high risk”. At the “quick win” end of the
spectrum, improved payment and purchase controls and faster
invoice-to-collection times, coupled with more effective debt
collecting, can have a rapid and tangible impact. This is
not simply a question of procedural change; it’s about
creating a cash-conscious company. “Underpinning these
activities should be a better focus on cash flow, so that
everyone knows what drives cash,” she says.
That understanding should inform your firm’s negotiations
with its companies and suppliers. A buyer may focus on achieving
the best price when buying components, but fail to consider
the effect that tight payment terms will have on the cash
situation.
Buyers should also be aware of tying up capital by buying
too much stock at one time. The problem is, of course, that
as businesses grow and become more complex it becomes harder
to control spending, purchasing and the negotiation of sales.
In an owner-managed business one person signs all the cheques,
monitors how clients are won and so on. In a multinational
conglomerate each business unit will have its own management
structure, sales team, purchasing department and financial
software package. “You can lose the ability to communicate
and end up with many financial decisions being made in isolation,”
Davies says.
The challenge is to reconnect the top of the organisation
with the outposts of its empire and to change everyone’s
behaviour. Senior managers should lead by example here.
In the longer term, many firms are tempted to take more radical
steps to improve their cash situation. But although a major
restructuring initiative such as outsourcing manufacturing
may deliver huge savings, such a move is risky and may have
unintended side effects. Davies cites the case of a furniture
supplier that decided to buy its products from overseas. The
products were cheaper and better made, so it seemed like a
smart move. What the company hadn’t realised was that
it would change the whole supply/payment cycle and this left
it struggling to manage its cash flow.
This is not an argument for avoiding all radical restructuring
proposals, but it is a cautionary note. “You need to
follow a process to ensure that all risks are identified and
planned,” she says. “Change programmes should
have an element of project management.”
Restructuring might help you to achieve liquidity, but most
firms must borrow at some stage to meet their cash requirements.
Money is currently cheap and lenders are eager to provide
it, but it’s important to consider the long term effect
of debt on the business.
“Everyone wants to borrow cheaply,” says Simon
Collins, head of debt advisory services at KPMG. “But
what they really need is robust access to cash.”
The cheapest finance deal may prove to be false economy if
the covenants attached to the loan prevent your company from
accessing funds when it needs them most. For example, what
would the consequence be if a shortfall in trading breached
a covenant? “It’s the quickest way to lose access
to funding,” Collins says. “It’s a classic
trap.”
You must ensure that you agree terms that you can adhere
to and, if covenants are important, don’t go for the
cheapest deal. Before talking to lenders, it’s important
to take stock of the business, not only to establish your
requirements but also to reduce the risk of breaching covenants
or defaulting on a payment. What are the forecasts? What are
the potential risks and opportunities? Are there extra contingencies
that the firm should be planning for?
Look at your business cycles and, if necessary, plan operations
for the bank and bond markets accordingly. You also need to
be clear about what you are borrowing for and how much you
need. For example, do you require core funding, working capital,
contingency insurance, or – as is often the case –
a mixture of all three?
When considering the amount of money you need, you should
also think about the most efficient way to structure the borrowing.
Do you need it to be available within the business at any
time or as a flexible credit facility? There is also a question
of whether you look to the banks or the bond market. For sums
above £100m, the bond market may be a viable alternative
to bank loans.
If the maturity of the debt is seven years or more and your
industry is not cyclical, the bond market can be cost effective,
according to Collins. But he warns that it can be a dangerous
choice for firms with weak credit ratings operating in cyclical
industries.
Of course, lenders do their own research. Potential bond-holders
will scrutinise your credit rating, while banks will want
to understand the competitive landscape and your company’s
position on it. One advantage of debt finance compared to
equity finance is that lenders have no ownership rights or
interest in your business other than ensuring that the repayments
are made. That doesn’t mean that you can ignore their
opinions, of course.
A recent corporate history illustrates, even rock-solid blue-chip
companies can find themselves in life-or-death negotiations
with their lenders when the market changes or a strategic
decision goes wrong.
Mick McLoughlin is global head of corporate recovery at KPMG, United Kingdom. This article is contributed by CIMA (The Chartered Institute of Management Accountants).
