Keeping the business heart beating

The threat of a recession may have been narrowly averted but Irish businesses are still challenged by rising costs and high-interest rates. Yet a perennial issue for small to medium-sized enterprises (SMEs) is cash flow, and even profitable businesses can go to the wall due to crippling cash flow problems.

Poor cash flow is invariably a symptom of poor health in a business, according to John Devaney, associate director at EFM UK & Ireland.

“It’s like having a sore leg or a bad back but the question is what’s causing it, what’s behind it,” he notes. “The interesting point that is often made is that profitable businesses can have very poor cash flow and break-even businesses can be absolutely fine; you would think it would be the reverse.”

The causes can often be quite simple, says Devaney. “One of the simplest issues is very poor cash management and a receivables ledger that’s not being monitored and not chased up on,” he explains. “It might just be that a business needs a credit controller who will chase up the money owed, but sometimes it’s even as simple as the invoice being incorrect or that they haven’t received the invoice. Sometimes they just need a little nudge, or the person who received the invoice has left that business and it needs to be followed up again.”

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Owner-managers spinning too many plates

Devaney notes that in smaller businesses, for example, an owner-manager may be so hands-on that the financial side of the business is simply not a priority. In addition, even the best-qualified entrepreneurs may not always have the financial acumen for this. “Even if they do, they can just get distracted,” he says. “They might only allocate a couple of hours a week to looking after the finances of the businesses and as long as there is enough coming in to pay the bills and the wages each month then they don’t have a clear picture of what’s owed to them in total.”

John Brennan, head of SME banking at AIB, agrees. “Cash flow is the beating heart of any business and requires laser focus to ensure the business can cover its overheads, pay employees and effectively run day-to-day operations,” he says.

According to Brennan, common cash flow problems can include late or partial payments, sales challenges, rapid growth (often referred to as “overtrading”) and excessive cash tied up in stock. “Businesses struggling with cash flow should avoid material capital expenditure from cash flow and avoid purchasing stock that appears attractively priced unless confident that it will be sold or converted into cash in line with normal stock turnover.”

The bad-debt issue plaguing Irish firms

The real risk of unpaid invoices is that they can quickly become bad debts, Devaney warns. “Slow cash collection raises the potential for bad debt and businesses going under or having to offer significant discounts to get paid.” This is endemic in certain sectors such as construction, which Devaney says is notorious for cash flow problems.

“They have to buy all the materials and do all the work and then when they do the final invoice they have to wait to get paid,” he says. “Small builders don’t have huge margins and they have overheads and they have already paid their workers so if they don’t get paid at the end of a job it can be absolutely devastating for them.”

Even major organisations can be tardy when it comes to paying their creditors; Devaney notes anecdotal reports of large supermarkets “stretching on credit. Some large supermarkets are very hard on their margins and their suppliers and are known for not being the fastest payers.”

A survey carried out last year by Bibby Financial Services found that bad debt is an issue plaguing Irish firms, with one-in-three SMEs in Ireland having to write off bad debts in the previous 12 months, and the average bad debt totalling almost €19,000. This is compounded by the fact that SMEs are dealing with a “heady cocktail” of rising costs on a daily basis, such as rising interest rates, high inflation, spiralling energy bills, ongoing supply chain disruptions and a significant talent squeeze, Stephen McCarthy, head of business development with Bibby, explains.

Many sources are predicting that the direct economic impact of business failure will be significantly higher in 2023 compared to 2022 levels, he notes. “As a result, we’re likely to see this pressure translate into even greater sums of bad debts, as payment disputes and defaults start to kick in,” says McCarthy. “It would therefore be prudent of SMEs to take a number of steps to ensure they don’t fall foul to non-payment such as updating credit control systems, completing full background checks on all customers before extending credit and ensuring strict payment protocols are enforced.”

Alternative funding options

With invoices now taking longer and longer to be paid, the situation could potentially get worse before it gets better, McCarthy says. Their survey also revealed that chasing unpaid invoices is the top financing problem for businesses, mentioned by almost a third of respondents.

The knock-on impact of this, McCarthy says, is that businesses are turning to expensive and “totally unsustainable” funding options to keep their business going on a daily basis. “Our research shows that a staggering one-third of SMEs are currently using credit cards, and over a quarter are relying on overdrafts to facilitate their daily cash flow requirements,” he notes. “Given the fact that credit cards and overdrafts require a business to take on even more debt at a time when they don’t need it, SMEs should be considering more sustainable solutions.”

Firstly, McCarthy advises, businesses should review their revenue stream to ensure there is no overreliance on one or two key sectors or customers. “Diversifying revenue stream and customer base will help reduce any potential exposure to bad debt, which occurs when businesses write off sums of money if customers cannot or will not settle invoices in full. This may be due to payment disputes, protracted default or, in some cases, the insolvency of another business.”

A good option such as invoice finance will then help shore up the cash flow situation, he says. This is a facility that offers businesses access to money outstanding from their unpaid invoices, helping them to access income they have already earned but not yet received. “This gives a company the option of using their own funds to improve day-to-day or seasonal cash flow fluctuations or finance bigger growth plans without having to borrow money,” McCarthy explains.

Brennan explains that AIB offers special business and farmer credit lines to help businesses plan over the course of the year. “By establishing the level of working capital support needed at the start of each year and arranging the necessary bank finance, businesses can have the required funding in place for planned seasonal purchases,” he says. AIB also offers invoice discounting.

Facing cash flow challenges

Of course, it’s better that businesses try to avoid cash flow problems altogether. “Businesses should take time to plan ahead and think proactively, maintain healthy cash flow and curb any potential cash flow problems to ensure they are best positioned to operate and grow their business,” says Brennan. “Some good ways to do this include revisiting their business plan, planning monthly cash flow and improving forecasting, managing profit expectations and minimising expenses.”

There are various tools available to help with this; AIB’s Small Business Cash Flow Planner helps businesses prepare a cash flow statement weekly and monthly for the next six months.

Brennan also advises SMEs to use their business network when faced with cash flow challenges. “Seek advice from your bank or financial advisor, your accountant or local Chamber of Commerce or Enterprise Office.”

But at what point do cash flow issues become a sign of a business no longer being viable?

According to Brennan, warning signs that a business should not ignore include consistently falling sales or the loss of key customers, sustained negative cash flow, and continual borrowing in order to cover shortfalls.

Devaney says that all businesses have certain fixed costs they have to meet. “You have to pay your VAT, you have to pay your taxes and you have to pay your rent,” he says. “If you are struggling to make those then you have to look at what’s going on.”

In the current climate, high inflation and high supply chain costs can creep up on business owners “very quickly”. “Especially when you are very busy running your businesses, the financial impact of this may be more serious than the business owner realises at the time.”