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Cash Flow & Forecasting Finance Rescue, Restructuring & Recovery

An interesting insight into the psychology of accepting too much work

too much work and a heavy loadI have warned in previous blogs about the dangers of over-trading and the effects it can have on an otherwise profitable business.
Over-trading is when a company is growing its sales faster than it can finance or fulfil them, in other words, taking on additional orders when it can’t afford to service or fulfil them.
The impact on cash flow is often concealed by the growing profits from growing sales.
The assumption that you cannot turn down business and must accept all orders is normally based on a rational fear of either leaner times in the future or that your customers will go elsewhere.
However, the American author and trader psychologist Rande Howell has an interesting perspective on the causes of and motivation for over-trading.
He outlines this in his book, Mindful Trading: Mastering your emotions and the inner game, and on his website mystateofmind.com.
While acknowledging that there is a fear element, the decision-maker’s fear of missing out, he attributes this to their mindset as a hunter.
The business leader, or trader as he refers to them, has a bias to act and therefore to chase after sales.
This can lead to taking action out of boredom because the mindset is about making things happen. Inaction, and the suspicion that opportunities are passing by, is therefore uncomfortable but it can also lead to acting on impulse rather than reason.
Howell also points out that there is a biological imperative in this behaviour in that the brain rewards success by releasing dopamine, the “feel good” chemical. Add to this Testosterone, which is associated with risk-taking and you have the elements of a behavioural pattern that can lead to over-confidence and unconsidered behaviour.

The danger of acting on impulse rather sticking to the business plan

As I have said before a well-organised business ought to schedule work and know when an order can be easily fulfilled.
When planning for growth, the business should look carefully at its finances and have a clear idea of its capacity.
I have also advocated in the past my view that those businesses with more demand than capacity should, instead of building more factories or taking on more staff, consider selling their existing capacity instead of selling more services or products.
This can be done in two ways, either by pricing to manage demand or fixing prices but managing expectations. No one minds waiting if the quality justifies the wait, at least until a competitor offers a similar quality at a similar price but quicker. This sale of capacity allows you to focus on quality of both product and service and avoids taking on more fixed costs in a febrile market.
Honesty and self-awareness, what Howell calls mindful trading, can help to combat the psychological components that lead to risk-taking and can strengthen the confidence in sticking patiently to the growth plan.

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Business Development & Marketing Cash Flow & Forecasting Factoring, Invoice Discounting & Asset Finance Finance Insolvency Turnaround

The Pitfalls of Overtrading

businessman turning out pocket empty of cashA business that is overtrading is one that is at risk of becoming insolvent.
Overtrading is when a company is growing its sales faster than it can finance them, in other words, spending money it hasn’t got by taking on additional orders when it can’t afford to service or fulfil them.
This relates to a lack of working capital to fund the business and the cash cycle of contracts where creditors are often paid before payments are received from customers.
In this way a company can be profitable and yet run out of cash.
While it is healthy for businesses to pursue growth, a lack of honesty with themselves and their situation and a lack of forward planning can put them in this position. The rate of growth needs to be realistic for several reasons, including resources and capacity, both of which normally require funding ahead of income.
While there may be a strong temptation to say “yes” to new orders, a business needs to be sure those orders can be fulfilled, not only to avoid damaging its reputation but also because ultimately it can lead to insolvency.

How can a business avoid overtrading?

When there are more orders coming in than there is capacity to cope with, one solution is to price work in a way that manages demand. This need not be simply by putting up prices but more by having a pricing strategy. It may be necessary to protect the relationship with long term customers by pricing loyalty and long term commitments. Alternatively, future orders or flexible delivery might be priced at a lower rate than late orders and short notice delivery rather like the airlines. It may be that there is scope for staff to work overtime and share the benefit of increased prices.
Another way of looking at demand is to sell capacity rather than goods and services. A well-organised business ought to schedule work and know when an order can be easily fulfilled albeit on its own terms. By managing customer expectations, such as for a longer delivery timetable, a business can establish a pipeline of future work to keep everyone busy, at a level that works for the resources and capacity.
Ideally, when a business is planning for growth, it should look carefully at its finances before it starts any marketing or sales activity with this goal in mind.
For SMEs, this could include looking at the possibility of accessing regional growth funds and other cash flow and asset finance options, providing they can meet the conditions. If more funds are available then a higher level of growth can be achieved.
Negotiating arrangements with suppliers may be another possibility, especially if the business has a long-standing and good relationship with them. They might value longer term commitments and provide extended credit terms.
Another solution is to manage trading terms with customers, for example by requiring the payment of a deposit up front, stage payments, payment on delivery or reduced payment terms.
Using factoring and invoice discounting as a means of freeing up finance to pay fund orders may also be a solution as this will provide access to cash before an invoice is paid.
Having a product or service for which it is clear there is a substantial demand is not enough.  To grow a business, resources and working capital are needed if it is to avoid the consequence of overtrading: insolvency due to running out of cash.

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Banks, Lenders & Investors Business Development & Marketing Cash Flow & Forecasting Finance General Insolvency Rescue, Restructuring & Recovery Turnaround

Has 2008 changed the pattern of insolvencies increasing on an upturn?

An increase in insolvencies used to be a reliable signal that the economy was coming out of recession.
Six years after the Great Recession in 2008 we are being told that our economies are growing, the recession is over, SMEs are reporting increasing orders yet there is still no sign of an increase in insolvencies.

So what is going on?

The reason that insolvencies rise in an upturn is because two things happen.
Firstly companies start to get an increase in orders, but unless they manage their cash flow carefully, or have adequate reserves of capital they risk overtrading – essentially not being able to fund the growth.
Secondly, secured creditors generally only call in loans when they think there is a fair chance of recovering their money, therefore during an upturn and in particular when the secured assets increase in value.
The consequence is that when creditors start to demand their money back and a company is overtrading it can’t realistically pay off the loan – the result is insolvency.
So in our view, the recession is not yet over, markets remain jittery, confidence is still uncertain and asset values are falling, hence fewer insolvencies.
Have we simply papered over the cracks?

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Banks, Lenders & Investors Cash Flow & Forecasting Factoring, Invoice Discounting & Asset Finance General Insolvency Rescue, Restructuring & Recovery Turnaround

How can smaller businesses fund growth in the economic upturn?

 

A new report by the Credit Management Research Centre and Taulia has revealed that UK companies have been relying heavily on trade credit.

It is also well known that traditional bank lending to SMEs declined by 20% in the last 12 months.

This is despite bank claims that they have plenty of cash to lend and a perception that they are declining loan applications. More realistically the decline in bank lending is down to loan criteria being tightened and the fact that credit worthy companies have been paying down loans instead of funding growth.

So how are small businesses going to fund the expected increase in business and orders that come with economic recovery from recession?

If a company accepts orders without being able to finance them it runs the risk of insolvency through overtrading, which is why so many commentators point out that most insolvencies occur during the upturn after a recession.

Given that many good businesses have used the recession to pay down debt, it can be assumed that their balance sheets have improved and therefore they will be easily able to raise finance for growth from the banks.

However there are a lot of SMEs that do not have a strong enough balance sheet to justify traditional funding. Where these sources are not available they are looking to fund growth using alternative sources of finance.

In the past such sources were myriad, such as from friends and family, negotiating deals with well funded suppliers, early payment terms from customers and even credit cards, but the banks remained dominant. Over the past 20 years asset based lending has grown since it can advance more funds than the banks due to the specific pledge nature of its security. More recently we are seeing a new route to finance from peer-to-peer and crowd funding websites.

The website based sources appear attractive and are often easier for obtaining funding but they can incorporate obligations such as a personal guarantee for the loan from the directors.

In April 2014 the FCA (Financial Conduct Authority) introduced new rules on loan-based (money loaned) and investment-based (share subscription) crowd funding that require the lenders to carry a certain amount of capital, to be open about defining the risks and to have resolution procedures in place in case of the lending platform failing.

It is likely that the online funding platforms will become stricter and require more information from borrowers before making a decision, but if used wisely they offer a great source of funding to growing SMEs.