NABs latest business survey for May has produced some interesting facts about the current state of business in Australia.
Business confidence rose in May in response to likely interest rate cuts as well as the Coalition General Election victory, but that’s where the good news ends. Business conditions, especially in retail and manufacturing are shown as being technically in recession. This should worry every business out there, but what can you do about it? There is indeed danger of worsening the situation and essentially talking ourselves into recession. Recessions, or sustained negative growth are all part of the business cycle, and companies that survive them should have a strategy in place to be able to survive them, and then come out stronger on the other side.
The NAB survey found that retail was suffering a 10% downturn, and manufacturing, 6%. What are your strategies for coping with such a down turn. Your strategy could also cost you $10ks more than it should do. As a case in point, we’ve run a little model on some of our demo companies within Jazoodle to see just how such a downturn would affect these companies. I believe every company should run these scenarios regularly and they will probably save you lots of money, lots of time, and possibly save your business
Let’s look at Company A. Company A are a manufacturer and according to the NAB survey, expecting a 6% downturn in revenues in the coming 12 months. They turnover $54 million. Their profits amounted to around $237,000 in the last year we have data, at around a 2% margin. End of year cash position was around $950,000
As we’ve said, being a manufacturer, business conditions are trending down around 6% on revenues. Assessing the company in Jazoodle, their business health is quite strong and reflects a normal business environment. Now, if we go to the modelling area, and reduce revenues by 6%:
On this assumption, we see that revenues would fall to $51.4 million and net profits to a loss of $-743,000.
Their balance sheet would fall by around $800,000 net assets driven by a cash fall of about $800k to only $102k (cash reserves would fall to 0.19% of revenues and with overheads sitting at $15m pa a very slender cash position). Such a scenario would mean the company needed to generate cash to shore up its solvency position. As any business owner knows, cash can be generated by one of a number of tactics: Increase Debt Funding, Increase Equity Funding, Reduce Overheads with cost cutting, or collect cash more efficiently from existing customers. Each tactic has costs attached. Which one would be right for your business?
In our demo example, (which is data from a real company), how would we best get through this possible speed hump in trading and cash risk? I’ll now use the Jazoodle model to model each of these tactics:
Increase debt financing
Long term loans in this company are set at around $200,000. If we were to increase long term debt by 2 x to $440,000 we’d see that this tactic would not provide enough of a cushion, all things being equal to offset the downturn in revenues fully. There is also the issue of servicing that debt, which would add around $13,000 in interest pa – a relatively low cost option but not covering the whole shortfall in cash.
Next, we could assess the use of equity financing and issue issue $1.2 million of equity – this would recover the cash position to about 10% of annual overheads. There is a cost to this of course, in the preparation of data and prospectus, the dilution of the existing equity and the overall cost of equity. Again, with the cost of equity likely to be a minimum of the 4-5% range, this may not be financially viable. For private companies, the time and cost of pitching, business case preparation, identification of institutions interested in private equity deals…..
Another option we discussed, is to become more efficient in the collection of client debt. We see, in our example, that this company takes on average, almost 54 days to collect its client invoices
The effect of lazy collections on cash is incredible. Let’s model a change in collections for instant to say 40 days average
As you see, changing the slider back around 25% to 40 days collections period is done in seconds. If we now look at the balance sheet on the modelling area, we see that cash position has recovered to around $2,000,000 – despite the 6% downturn in revenues
Now, the key question, is can the existing finance team reduce the collections period without further overhead? Let’s for arguments sake say no, and we have to add specialist Accounts Receivables staff with a wage bill of about $250k pa to achieve this. Increasing overheads by that amount on the sliders shows what effect this will have on both the P and L and Balance Sheet Cash position (and valuation!)
We see that the P and L has worsened, a little, but the Balance sheet has remained relatively strong.
The power of modelling scenarios in any business is plain to see, and I hope we’ve demonstrated just how much that could mean to any business. In this case, although we see that this company would need to raise cash to offset a reduction in revenues of just 6% and in line with the NAB survey, it does not need to dilute equity, nor take on debt financing. It needs to probably employ additional finance staff. We could also take this scenario further and assess a reduction of overheads through some minor cost cutting – which my well give a cost neutral approach to raising cash overall.
The power of scenario modelling is immense. With the recent survey from NAB, I believe that every business should NOW model how an expected downturn could be overcome within their business. Jazoodle costs $440 per year per business. Isn’t that a great investment when – in the above example, you will and within a few minutes, assess your best course of action and then assess the cost of that course of action. As I said, $440 versus Interest on debt, or dilution in equity or running out of cash!
Andrew Paton-Smith is the Founder and CEO of Jazoodle
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