Business vitals: where to look to avoid default

The vast majority of companies in New Zealand are small or medium sized businesses. The people behind these businesses usually have a strong desire to earn enough profit to enable significant returns for the organisation’s shareholders.

However, the reality is that very few businesses achieve the level of returns shareholders desire — many businesses may achieve no returns at all or fail.

So, what are the points to watch to avoid trouble in the foreseeable future? Consider these four important aspects of day-to-day business.

Keep your cash flowing

1) As they say: “Cash is king.”

All businesses need money to survive – cash is needed to pay employees, suppliers, repay the investments and loans to the company, as well as tax obligations.

In our experience, many businesses that end up in liquidation or receivership have had cash-flow issues for a significant period of time. The following questions will turn up red flags around an organisation’s cash flow:

Are you or your clients, constantly outside the terms of the overdraft facility?
Are you or your clients regularly extending payment terms to significant suppliers?
Are your debtors slow to pay?
Are you behind on your IRD obligations?

These are all symptoms of companies with cash flow problems. Looking to extend your credit terms with suppliers may buy some time, but the key is to ensure focus is not lost from basic credit control. Collect your debts and do not extend further supplies if payments are not made on time.

2) Maximise revenue

Very few businesses have a perfectly constant and predictable level of revenue – sales (of goods or services) continually fluctuate due to a variety of factors.

Whilst sales may change over time, in the short to medium term, businesses do not typically have the ability to adjust fixed costs proportionally. The effect of this is that decreasing revenues directly reduce profit levels which ultimately will erode cash flow. Conversely, increasing revenues puts the business on the path to increasing profits and available cash flow.

Where sales have declined, directors and advisors need to make an assessment of the root cause of the decline in sales. There can be many reasons why revenue decreases, some which are more easily rectified.

An effective tactic in boosting your revenue is maximising the contracts the business already holds. It is much easier – and more cost efficient – to sell products or provide services to current customers than it is to attract new ones.

Another option is to extend the geographic market areas served by the business. Many organisations limit their marketing and sales efforts to the immediate area surrounding the central location of their business. Perhaps it is time knock on neighbouring doors.

3) Increase profit margins

Aside from sales decreasing, in the light of heightened global competition, many businesses are faced with lessening gross profit margins.

There is not always the ability to increase prices to respond to increases in input costs. The decreasing margins mean that sales need to increase to give the same contribution towards fixed costs, and ultimately profit.

Directors must also consider whether the product or service they are offering contributes enough (or at all) to the bottom line, and if not, determine what changes can be implemented to improve these margins.

This can be best carried out through an internal audit. Review your outgoings and incoming revenue. This will highlight any costs that seem particularly high and any parts of the business where your revenue has inexplicably dropped.

Pinpoint the gross profit margin on each of your products and services. This will help you identify both low margin or loss-making services or products. Then you can stop selling low margin lines and focus on the ones that work.

Reviewing your spending and seeking ways to increase profits should be a constant and ongoing process.

4) Make sure your books are tidy and accurate

A company director should be able to accurately determine the financial position of the business at any time. It should also be relatively straightforward to identify what creditors need to be paid, and what debtors are due and payable.

We regularly see businesses which are unable to do this and when we are appointed, we are advised there are substantial debtors outstanding. Some may have already paid or even never received the goods/services in the first place. However, when we seek to collect payment, it is apparent that many of the listed debtors are not debtors at all.

Similarly with creditors, we regularly receive creditors’ listings with missing creditors, or inaccurate balances for the creditors. This information must be kept up to date as directors have a statutory obligation to keep accounting records. Further, not doing so makes it impossible to monitor the performance of the company.

I think my business might be trouble. What steps must be taken?

Directors owe a duty of care to creditors and shareholders of the Company to recognise these warning signs and act when they arise. Directors are often optimistic, with “the next big contract” pending, and their advisors need to ensure the director has undertaken an objective assessment of the situation.

Once the issues are identified, actions must be promptly taken to rectify the situation. Prudent decisions need to be made. Consider the following:

What costs can be reduced?
Can you increase sales?
Can you better collect your accounts receivable?
Can you increase prices?
Can you sell the business?
Consider if the business can be turned around – does liquidation or voluntary administration need to be considered?

Whilst some of these issues may be temporary, it is incumbent on directors to identify how significant the problem is and to act promptly.

Albert Einstein once said, “Insanity is doing the same thing over and over again and expecting different results.”

This applies as much to business as to anything else; problems are unlikely to rectify themselves and steps need to be taken to improve the situation – or at the very least stop things getting worse.

The earlier these issues are identified, the more options there are for all involved.