Bank On It
Don't Wait for a Cash Crisis
Many businesses today are finding their revenues slipping while their costs are climbing. Some companies may be holding onto revenue levels but find less cash in the bank as the rising cost of goods, freight, energy, medical benefits, rent and other expenses cause margins to shrink. This is a critical time to understand the changes in your business’ financial situation. It is important for every company to address early warning signs to avoid issues that could impact company operations in the long term. In tough times, a company can improve its ability to survive through adverse economic conditions by addressing early warning signs as they arise.
Early warning signs include:
- Reduction in cash position
- Occurrence of bank overdrafts
- Increased reliance on debt, including credit cards, lines of credit, etc.
- Drop in revenues
- Slowdown in inventory turnover
- Slowdown in Accounts Receivable Days and/or Accounts Payable Days
- Lower gross margin or profit margin
- Increase in expenses
- Failure to meet financial projections
- Net losses
If your company’s financial situation reflects any of the above, your business is showing early warning signs of potential problems. The quicker the issues or problems are identified, the more options there will be to remedy or at least minimize the impact on the over-all operations.
The cause of a warning sign may not be readily apparent. Since it may be the first in the history of the company, management needs to put some time and effort into identifying the source and appropriate solutions. Four preventive actions are recommended.
First, the business should increase its efforts toward obtaining timely and accurate financial reporting, whether it relies on its accountant, bookkeeper or uses its own software package. The information will play a significant role in identifying problems and measuring the success of changes. Current financial information will allow management to quickly measure progress and determine if actions are working. Without timely information, the problem could go unresolved for a longer period and management will miss opportunities to remedy the situation.
For example, the cost of sales has a daily impact on a company’s bottom line, so if you only address it on a monthly basis it may be too late to turn it around within the next month. When a company is spending cash each day faster than it brings it in, every day puts the business further behind draining cash balances.
Second, during these challenging economic times, a company needs to update its business plan; go back to the basics. It is important to understand your customer. Ask yourself, “How has the current economy changed my customer’s spending behavior? How can I more efficiently produce or distribute and sell my goods or services? How elastic is my pricing?” Play on your strengths, such as the quality of your products or excellent services. There may be services you offer that will be more valuable during this time. Also, look for ways to reduce the cost of goods sold, overhead and other expenses. It is important not to over-leverage yourself. Avoid increasing your debts to finance losses. Increasing your debts to finance losses will not solve the problem and will only lead to a larger one.
Management’s plan should be detailed and realistic about the economy, including the likelihood of decreasing sales. The plan should also include a break-even debt service scenario to determine the lowest sales can decline and still pay all debts. A new financial projection should be prepared that can be used to track the success of changes, such as improvement in the gross margin, reduction in expenses, build up of cash reserves, and paying accounts early to obtain trade discounts.
Third, it is important to know that if management senses a challenge repaying its loans, prompt communication with creditors is critical. Most creditors will want to work with the business collaboratively and amicably.
Finally, do your homework and keep up to date on industry trends, seeking advice from qualified resources that have experience in working with the early warning signs you have identified in your operations.
Your banker and accountant can provide you with valuable advice when it’s time to take preventive action.
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