LOSING SIGHT OF CASH FLOW

CASE STUDY:This month's case study looks at how the new manager of a successful cabinet making company got caught up looking too far into the future and fatally neglected day-to-day issues such as bills and wages

FOR AS long as he could remember, John O'Malley enjoyed making things. He was apprenticed to a cabinet maker directly from school and developed a particular skill making reproductions of antique pieces for display in period homes and historic buildings.

The economic crash of the 1980s hit his employer's business hard. Work slowed to a trickle and staff were laid off one by one. Eventually the business closed and O'Malley lost his job.

O'Malley's skills were not easily transferred to another industry and with jobs thin on the ground, even for those with qualifications and experience, the situation looked far from hopeful. With a young family to support, time was not on his side.

It was his wife, Vera, who suggested he set up a small woodworking business from home. He built a workshop in his garden and began with commissions from neighbours and friends, making everything from bookshelves and wardrobes to fitted kitchens. But the real turning point came when a local shopkeeper asked him to make an old-fashioned wooden display unit for home-made bread and cakes.

The customer was delighted with the result and Vera, who turned out to have a natural flair for sales, took photos of the unit and began approaching other shops. The order book grew steadily and after 18 months, the business relocated to a small industrial unit on the outskirts of Wexford town.

John took on two people to help with production while Vera looked after finance and administration with the help of a part-time employee. Business came primarily through word of mouth. Producing a quality product from day one was critical to building the company's credibility. By 2002, the business was thriving. It employed a total of eight people, including the proprietors, and its annual turnover was rapidly approaching €1.5m. Margins were tight, but averaged around 6 per cent.

Bespoke items were still a valuable contributor to sales, but a range of off-the-shelf, self-assembly units which O'Malley had developed were a major contributor to the company's growth. While wood was still his primary material, O'Malley had also introduced more cost-effective materials such as MDF and some plastic components to cope with spiralling costs.

None of the O'Malley children had shown any great interest in the family business, although middle son, Seán, had studied technical drawing before moving to Australia.

His decision to return home in 2007 surprised his parents, but they were even more surprised when he said he'd like to join the business. And the surprises didn't end there. The couple's eldest son, Paul, a quantity surveyor, also decided to get involved.

This turn of events suited the O'Malleys very well. They knew there was potential to grow the business further, but now in their 60s, they felt it needed fresh blood and enthusiasm. The brothers got on well together and the O'Malleys believed they would bring new skills and commercial experience to the business.

Following detailed legal and financial advice, the brothers took over the business. After an induction period of six months, their parents stepped back from day-to-day operations, but remained on hand to give advice.

The brothers had plenty of youthful energy and drove the business hard, which resulted in further profitable growth. With their tails well and truly up, they began to look for larger contracts. They saw big potential in one particular product, a display unit for fresh baked goods not unlike the one their father had pioneered over 20 years earlier.

Only this time the sons were keen to use a combination of wood veneer and plastic moulded components to keep costs down, while maintaining the appearance of a high quality solid wood unit.

This approach was soon vindicated when they secured a major order from one of the smaller supermarket symbol groups for this product worth €350,000. It was by far the biggest single order the business had ever won and it was also an extremely profitable one. When all the costs were factored in, the margin of 10 per cent was the best they had ever achieved.

Vera was concerned that the order was so big that it would occupy everyone full time for months. She worried the boys were biting off more than they could chew, but John was extremely proud of what his sons had achieved and assured Vera he would pitch in to keep the show on the road. He believed it was the time to support his sons not to hold them back.

The brothers worked flat out to meet the promised delivery schedule for the new units. Miraculously, the few technical problems they experienced were quickly sorted out by their father.

The customer was delighted with early samples of the units and had already begun talking to them about another possible contract that would bring them into a new, but related area of opportunity.

Even Vera began to feel her initial caution had been unjustified. Then one morning she received a panic phone call from Seán. The bank had been on to express concern about the size of the overdraft they had run up and the manager wanted to see them without delay. Vera went straight to the factory and sat down with the books. With a heavy heart she quickly identified what had happened.

The boys had been so focused on getting the order out that they had taken their eye off what was happening to cash flow within the business.

In order to fulfil the new contract, they had invested in a plastic injection moulding machine and a number of bespoke component moulds.

But rather than leasing or borrowing to buy the equipment, they had paid cash.

Furthermore, the injection moulding machine they bought was actually larger than they needed. It had been available at an excellent price (only a few thousand euro more than the smaller one they had first looked at) and the brothers felt it would give them more flexibility and capacity for future contracts.

They had also hammered out a good deal on raw materials, negotiating a big bulk discount from their supplier, which gave them an even bigger margin on the order. But it had also given them a store room full of raw material for which they had no immediate use.

Finally, they had taken on two additional staff to cope with the increased volume of activity. This combination of circumstances had made the business cash negative in less than three months.

The company had only received a small deposit on the new order, but had incurred heavy outlays in relation to it.

The boys felt that every single item of their expenditure could be justified, because it was being incurred in pursuit of a contract that looked highly profitable on paper. But they had failed to see the bigger picture and by taking on such a large order, they were effectively over-trading.

Now the bank manager was on their case, wages needed to be paid at the end of the week and the boys were left wondering how on earth they were going to meet their future bills. How could such a sweet deal have turned so sour so quickly?

What options are open to the O'Malleys? Read the experts' advice