Why it’s more important than ever to improve your working capital position, and the best ways to go about it.
Is your business struggling to access liquidity for financial flexibility? You’ll probably find that you’re not as alone as you think.
Achieving and maintaining positive working capital in 2020 may feel a lot like navigating a minefield. But as we move into a new financial year, the time is right to look at ways to improve your working capital and ensure your business is prepared for the next 12 months.
Aussie businesses struggling to stay liquid
The impacts of the COVID-19 pandemic on Australian businesses cannot be understated. The latest Australian Bureau of Statistics (ABS) figures for June show that across all businesses, 24% experienced revenue decreases of at least 25-50% less than June 2019.
The ABS data showed that as of June, 1 in 5 businesses (21%) believe that the length of time operations could be supported by currently available cash on hand is 1 to under 3-months.
Further, heavier hit industries like accommodation and food services, found more than 1 in 10 businesses (15%) believed that the length of time day to day operations could be supported by available cash was less than a month.
Even with financial relief offered by the government and some financial institutions, businesses will most likely feel the financial pinch when debt holidays are over, as Australia enters its first recession since the 1990s.
In an interview with the Australian Financial Review, Airlie Funds Management portfolio manager, Matt Williams, said that banks were “set to bear the brunt of the stimulus removal”.
"We've got 10% of mortgages on deferral [and] 6% of SME loans on deferral. So ... as some of the stimulus is withdrawn, what's going to happen to the bad and doubtful debt charge?"
With debts potentially growing out of control and access to cash becoming increasingly difficult, improving your working capital position can be a critical step to successfully navigating the next financial year.
What is working capital?
Working capital is a measurement of your business' liquidity and is the difference between the current assets and current liabilities.
If your business has a buffer of current assets that it can use to pay current liabilities, it is said to have positive working capital, and is an indicator of a strong financial position. If your business has less current assets than current liabilities, your business has negative working capital. This means your business is at risk of not being able to pay for operating expenses and short-term debts, which can trigger insolvency.
A common tool for analysing a business’ working capital position is the working capital ratio, or current ratio, which is Current Assets divided by Current Liabilities. A general rule of thumb is to have a current working capital ratio of 1.2-2.0, although this will vary across each business.
Given the uncertainty in the economic outlook, it’s probably a good idea to err on the side of caution by holding an extra buffer of current assets. This can be used to cover your current liabilities in the case of any negative shocks to your business.
Here are a few ways to improve the working capital position of your business:
1. Earn more profits...
Earning more cash profits boosts your cash balance and improves working capital position. This is difficult at the best of times, and even more challenging for most businesses during the COVID-19 slowdown. However, this is the best way to improve working capital, if it’s possible.
2. Raise some equity capital
Working capital is the difference between current assets and current liabilities and shareholders equity has no direct impact on a business’ working capital position. That said, if you issue equity in your business and receive cash, the amount of current assets rises and your working capital position improves which can help reduce stress during these uncertain times.
3. Borrow money long term
Current liabilities include debts that are payable within the next 12 months. By extending repayments as much as possible, you will minimise your current liabilities and improve your working capital position.
If you have existing borrowings, refinancing debts that fall within the next year to longer term liabilities will boost your working capital. This can be done by extending existing business loan terms to lower your repayments over the next 12 months. Or you might be able to refinance your equipment finance or commercial loans so any balloon or residual balances are pushed beyond the next 12 months.
4. Refinance your loans
If your existing business loans are hindering your cash flow and working capital through high interest rates, you may want to consider refinancing to more competitive options.
According to figures from the recent SME Growth Index by Scottish Pacific, 18.7% of small businesses are moving away from traditional banks and planning on using non-banks. This is due to non-banks allowing businesses to borrow without property as security (21.3%), reduced paperwork (19.8%), and short application times (17.1%).
Generally, non-banks are able to offer lower interest rates, fees and charges than the major banks due to their having lower overheads. Switching to a lower-rate business loan from a non-bank would allow you to reduce the overall cost of your liabilities and free up some much-needed cash.
If your business is performing well and/or has strong business assets to use as security, you will be in a strong position to refinance on more attractive terms.
Earlypay is a non'-bank lender providing financing to Aussie businesses. If you’re considering refinancing or even taking out new loans for invoice, debtor financing and more, Earlypay is able to provide competitive business financing solutions that suit a range of needs.
5. Sell underutilised long-term assets
If you have long-term assets that are underutilised or sitting idle, it could be a good idea to revisit whether you need to own those assets, or if they can be sold. If they are sold for cash, your working capital position will receive an instant boost.
It’s common for business owners to be reluctant to sell these assets as they “might” be needed, but in these difficult times, it’s often necessary to make hard decisions to stay afloat. Also, if your long-term assets are sitting idle, then you can bet they are for other businesses too. This means that you will be able to rent or lease many of these assets on a short-term basis if the need for them arises.
It’s more important than ever to closely monitor your business’ working capital position and take measures to improve it where possible. Failure to do so can put your business at risk and lead to stress that can often be avoided with some forward thinking and preparation.