In any given year, a cohort of businesses will, unfortunately, hit the wall.
Revenues may be flagging, costs may be escalating, and customer reviews may be scathing, but the killer blow to any company is usually the point at which the cash runs out.
There are more businesses hovering on the verge of bankruptcy than you would think.
Why are businesses strapped for cash?
After all, in the decade to 2020, it was a common financial practice to practice lean working capital. What does this mean? It means reducing the number of assets held by a business while still operating as normal.
For retailers, this meant reducing the amount of money tied up in stock. By placing more frequent, smaller deliveries, they avoided the need to find the cash to make bulk orders of stock which would sit on a shelf for two months before being converted to cash once more.
For other businesses, this meant working with as little cash on hand as possible. Gone were the days of holding a war chest of cash on the balance sheet. Instead, corporate cash has been used to fund dividends or share buy-backs to return the money to investors and boost shareholder returns.
The purpose of keeping working capital low is that a business ‘costs’ less cash to own. This means that its profits or dividends will be larger as a proportion of the investment made by shareholders. It’s simple math that leads to a higher return on investment and makes common sense. Given that cash is in limited supply, companies should use as little of it as possible so that the maximum economic activity can occur for a given amount of capital.
The dark side of lean working capital
All extreme strategies have trade-offs, and the trade-off of lean working capital is that companies which apply it will be less financially resilient.
A retailer with low inventory will find their shelves empty after a panic-buying spree or supply chain issue.
A business with low cash reserves will find its coffers empty if a large customer is suddenly unable to pay its debts.
Of course, due to the recent events of the global pandemic, these common scenarios have played over time and time again in British businesses up and down the country.
How do experts bring businesses back to life?
Corporate restructuring groups will initially perform a cash flow analysis of a company to understand exactly how a company was generating cash and where it was spending it. In such pieces of financial analysis – the timing of inflows and outflows is almost as important as the size of them.
A company that is making a small loss on its sales could have a healthy cash flow position, while inversely sometimes even profitable businesses can run out of cash.
By understanding the science and the dynamic of how cash moves through a business, the experts can identify the points of weakness and perform benchmarking against competitors to suggest whether there is a course of action that can lead a company to better financial health.
The experts are often engaged after a point of no return. At this point, the company is struggling to pay existing debts and has no opportunity to trade its way out of the cash shortfall.
In such scenarios, the insolvency practitioner may apply to the courts for a temporary order which prevents creditors from pressing their demands upon the company. This can buy the Board of Directors vital time to raise additional finance from external sources (or their own private wealth) to inject the company with the funds it needs to remain solvent.
With the one-off infusion of cash, combined with a more aggressive approach to debtor and creditor management, any viable business should be able to trade its way back to a sustainable position. Depending on the source of financing used, however, this may come at the cost of dilution of the original shareholders’ holdings in the business.