• Date

    24 Sep 2021
  • Category

    Restructuring & Insolvency

Working Capital Vacuum Threat as Recovery Continues

A severe shortage of working capital seems set to cause a growing number of business failures as companies responding to the recovery become overstretched due to a lack of cash.

Working capital is the liquidity available to a business that is not tied up in daily operations and is a key indicator of the health of the enterprise. The economy is reaching the point where a shortage of working capital becomes common.  

When a recovery is underway and demand from businesses and consumers increases many companies will face a liquidity crisis. Entrepreneurs naturally want to pursue opportunities but if cash coming into the business gets out of sync with cash leaving it , the company will be unable to meet its obligations, and tension develops, classic overtrading.

Working capital problems arise when there is a gap between a sale and the collection of the cash. During that time overheads continue, staff and taxes need paid, and cash problems tend to escalate. If supplier credit terms are tightened but sales increase, the working capital requirement becomes greater and a business with rising demand can quickly face a cash flow problem. 

There are countermeasures. But management must be brave enough to adopt early intervention rather than hope for the best , a mindset which often escalates in to cash flow crisis. 

Steps that businesses can take to optimise their financial position include:

Financial Data – Decisions should be based on real time and accurate financial information which comes from investment in quality software, systems and staff and advice.

Visibility – A 13 week rolling cash flow forecast tracking receipts, payments and pending costs is a pre-requisite otherwise the business is flying blind.

Proactive invoicing and collections – A forensic review of all processes that turn orders into cash will identify inefficiencies in cash retention and cash flow.

Review Inventory Strategy – Match stock to orders and consider a ‘Just in time’ stock policy.

Stakeholder Relations – A communications plan should be prepared for each stakeholder group impacted by cash flow problems, from customers and investors to staff and suppliers.

Economic recovery is understandably hailed as a welcome respite from economic problems, but it always brings challenges for businesses, most notably working capital and cash flow.

Despite the funding and equity options available to businesses, cash remains king. Cash is essential to repay debt and finance growth, but a shortage can precipitate failure and is often a problem that can be managed with early intervention.

For further information regarding any of the areas discussed above, please speak with your usual Azets contact our Restructuring & Insolvency Team.

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