Commercial credit, when used correctly, can be a valuable resource for business growth or asset acquisition. At MCP, we conduct key financial performance checks at the outset to gain a better understanding of the numbers.
As such, we have developed an acumen for spotting funding red flags. Business owners may be unaware of these issues or have not had sufficient time to address them. Therefore, the business may need to develop a remediation plan to identify and address funding red flags.
1. Short-term funding for long-term assets.
Issue: Incorrect matching of the funding term to asset life. For example, where six-to-twelve-month term loan is used to purchase assets providing longer-term business value. The cash flow return may not match the time required to repay the loan.
Fix: Seek a term of debt that matches the financial benefit the asset will provide.
2. Overdraft facilities are always at the limit.
Issue: An overdraft or other working capital is always fully drawn to its limit. Or it is sometimes paid down, only to be redrawn to its limit quickly.
Fix: Understanding of the business’s ‘Working Capital Days’. Investigate if receivables are taking too long to convert into cash. Perhaps money is tied up in slow-moving inventory. Remediate as required and then determine the appropriate limit on working capital debt.
3. Poor or lazy financial hygiene.
Issue: Where statutory requirements and tax commitments are overdue or non-compliant.
Fix: Seek to understand what is actually happening and remediate the situation. Are the business owners in communication with their financial advisers or need to build an advisory team? Communicate with these creditors and establish payment plans where appropriate.
4. Operating Profit is not translating into Cash Flow.
Issue: The Profit & Loss is reporting a sound Net Profit, yet the business is still short on cash.
Fix: Start by identifying the ‘Cash Profit’. Determine the differences between cash profit and accounting profit, and why. Are assets financed correctly? (See Point 1.)
| Accounting Measures | Cash Measures |
| Revenue | Cash Receipts |
| Cost of Goods Sold | Payments to Suppliers |
| Depreciation | Capital Expenditure |
| Interest | Loan Repayments |
5. The business tries to fund ‘permanent’ working capital
Issue: The business has an unhealthy balance sheet. Most businesses need a foundation level of working capital to be held permanently. This Permanent Working Capital (PWC) cannot be funded by debt, and owners should refrain from stripping this PWC cash out of the business.
Fix: Identify the amount of permanent working capital. Is it changing? Inject more equity into the business if need be.
Also consider business stages.
These red flags or business indicators need to be considered in relation to the stage the business is in.
- If the business is young and the ownership is motivated to grow it, then they may need to gain a better understanding of the business metrics that will support a growth strategy.
- If the business is maturing and growth has plateaued, perhaps an objective independent opinion is necessary.
- For owners nearing retirement or who have other distractions, succession planning may be necessary to introduce new ownership and reinvigorate growth.
MCP Debt Advisory can assist
Preparation is the key to enabling the business to present a clear picture when seeking commercial funding.
Staying ahead of the red flags will promote solid relationships with lenders over the long term and lead to better business debt management.
Contact MCP
1300 510 816 or your Finance Partner
enquiry@mcpfinancial.com.au
Follow us on LinkedIn The team at MCP Financial Services has specialised expertise in structuring complex debt arrangements. We can assist with review and restructuring, refinancing and renegotiating.