Nothing stops a company in its tracks faster than running short of working capital. The prolonged credit crunch has put a high priority on companies sorting out their refinancing well in advance. It has also forced many to think long and hard about both internal and external sources of cash to bolster their capital, particularly since there still seems to be plenty of anecdotal evidence that bank lending continues to be difficult for companies to obtain.
According to Michael Derry, finance director at freight and logistics company Redhead International, any company that can lessen reliance on bank borrowing in today’s economic environment is putting itself in a much better position, with a lot more options. “There is no doubt from a finance director’s perspective that it makes running your business so much easier if you can be confident that you have the appropriate amount of working capital in place,” he says.
But it goes far beyond simply making life more comfortable for the finance department. Derry points out that being able to show a strong cashflow stream and a solid working capital position on your balance sheet often enables the company to get much better prices from its suppliers.
“Credit referencing agencies look at your account and give you a much better credit rating if they can see a strong working capital position,” he says. “That makes suppliers much happier and they are going to extend better terms.”
At the same time, businesses should not be overly afraid of gearing. “All businesses need some gearing or you are probably being far too cautious,” says Derry. “If you have that much cash on hand that it can meet all your working capital requirements with no borrowing, then you are probably not making use of your cash efficiently.”
That said, a strong cash position is a great help if the company has the opportunity to acquire a competitor. “When the management in the target company sees that you have a good cash position, you become much more attractive to the seller. They know you are not messing them around and trying to find out how their business works on the cheap,” he says.
Brian Shanahan, a senior director at working capital consultants REL, says one of the ways that large plcs have been raising additional working capital is by using their receivables as security. This is different from invoice discounting, since the debtors’ book is simply being used as support for the company’s overdraft.
However, it does often allow the bank to provide a much deeper overdraft than one secured on the company’s assets or on director guarantees. One of the prime conditions for a bank accepting a company’s debtors’ ledger as security for working capital, apart from the quality of that ledger, is that there are good debt collection processes in place in the company concerned.
Another route for additional working capital is supply chain financing by the banks. That was very much a developing area, Shanahan says, prior to the crash, but banks have withdrawn much of their support for it over the last year. “There are all these products out there, but the acid test is the extent to which banks want to offer or support those products at the current time,” he says. “What we are finding is that the big plcs are being very focused in their internal management of cash and are managing their working capital portfolio a great deal better, whether it be getting better terms from suppliers or pushing for longer terms from creditors. The upshot of all this is that they need less debt than they did two years ago.”
Another source of additional working capital some companies are turning to is to “sweat” their intellectual property (IP) portfolio by looking to either sell or license IP to rivals in their sector. Alison Price, partner at law firm Maclay Murray & Spens, says that some are even using IP as additional security to support or increase the amount of working capital they can leverage from their bankers.
“IP used to be something that businesses routinely renewed, in the form of patents or trademark rights, every five years as the renewals fell due. Now we are seeing a definite trend for them to manage their IP much more closely,” Price says. “In fact, we have a number of established clients who are using their IP to raise significant amounts of additional cash from banks.” The way this works in many instances is that the company assigns the IP to the bank, which then has a saleable asset if the company defaults. The bank then licenses the IP back as part of a loan contract.
Martin Kilberry, finance director at Greenbank, which provides specialist products and engineering services to heavy industries such as coal-fired power stations, had to solve the problem of meeting the requirements of demanding clients who required the company to post a substantial bond at the start of contracts. This is not uncommon where the supplier is engaged in large projects which will leave the client in difficulties if the supplier’s business was to fail.
Kilberry’s problem was compounded by the fact that the company’s bankers had reduced the company’s modest £300,000 overdraft to a “contact if needed” basis, promising nothing. He solved the problem by switching to a bank that was prepared to provide a guaranteed overdraft and a £1m bond line facility. The deal was done in the early days of the credit crunch and shows that reworking banking arrangements can be achieved if the company is prepared to put in the legwork to find a willing bank.
“We now have an approved £750,000 overdraft in addition to the £1m bond line – and it has been a huge help in enabling us to push for higher value orders from clients,” he says.
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