Tom Lawton, head of manufacturing at BDO LLP, accountants and business advisers, recomends manufacturers maintain a focus on costs and working capital management as the economy starts a possible recovery.
We have just been through a period of enormous economic uncertainty. The rapid contraction in activity across the world now looks set to be followed by a long road back to recovery. Whilst this is a cause for some optimism this is also a time in the economic cycle when a return to sales growth can provide immense pressures on working capital and cash flow – and can unfortunately lead to an increase in business failures. Manufacturers will need to keep a close eye on their business fundamentals.
1 Stay alert and respond quickly to early warning signs
Keep talking to customers, suppliers and advisers. Make sure that you respond to warning signals coming from your customer and key suppliers, and understand what those signals might mean. You need to ask yourself a few things. Are prompt paying customers becoming late payers? Are suppliers requesting advances in payment terms? Are there rumours that a customer or supplier has business or contract problems? Are you picking up worrying messages from the credit rating agencies? These unusual trends might be alerting you to problems. Look for and understand these issues and develop appropriate responses and contingency plans. Panic is not required – but a strategy might be!
2 Maintain the focus on working capital management
The crisis has already forced manufacturers to take actions to manage their costs, reduce inventories and generally improve their focus on working capital management. An increase in trading normally places additional pressures on working capital and funding requirements – and many businesses may find that they have significant cash flow pressures at the very time that business seems to be improving. My advice is to maintain the focus on cost reduction exercises, do not increase staff numbers until further into the recovery cycle, continue to push hard to minimise stock levels and be even more cautious of your customers and their debts.
3 Monitor cash flow and profits
Make sure that your profit and cash flow forecasts are up to date and that they reflect the current economic conditions/ expectations for sales and costs. Keep your forecasts up to date and ensure they roll for at least 12 months ahead in some detail. This enables you to understand the performance and cash flows of the business and will identify any funding pressure points. If you foresee funding issues, develop a response strategy as far in advance as possible. In this nervous market your funders and other stakeholders do not like surprises, so they should be avoided at all costs!
4 Understand and optimise your funding arrangements
Although your funding arrangements may have built up over time, they may not reflect the current optimum structure for the business. Can you move “excess” short term higher risk funding to longer term loan arrangements? In addition make sure that you understand your security and covenant arrangements and build these into the assessments being made in point 3 above. If your covenants are under pressure or you think may breach, take advice sooner rather than later.
Finally this crisis has shown how important the credit rating agencies and credit insurers are in the business cycle. How often do you monitor your ratings? How often do you meet with your credit insurers to discuss your business? Without wishing to be too gloomy, our recent research Industry Watch indicates that the level of manufacturing business failures will maintain at a very high figure in 2010. Many of these failures will be as a result of this stretch on working capital and available funding. Managing the basics may help your business through this next phase of our difficult economic journey.
