SMES AND FINANCIAL LITERACY

Written on the 10 December 2014 by Grant Field

SMES AND FINANCIAL LITERACY

AN Australian-owned small business with a turnover of more than $10 million should not be going broke. So why, recently, has there been a spate of small businesses doing exactly that?

There can only be three reasons why these businesses find themselves going into administration. Either they are getting poor financial advice, are getting good advice and not implementing it, or are not seeking the appropriate advice in the first place. Most of my experience has been with the latter.

It's not rocket science. Invariably, the business runs out of cash-flow and there are only three reasons businesses dont have cash; and this applies regardless of the size of the business.

There are a lot of business owners that simply dont know what they dont know. That's not intended to insult business owners; it's a challenge for those of us advising family and private business. Business owners are busy building their business. They're good at what they do and that is their focus. Our challenge, as advisers to business owners, is to raise awareness of the benefit of having access to that advice.

As an example, what continues to surprise me is that very few business owners know what rate of return on capital employed they're making on their business and whether that rate of return is high enough. Most business owners can tell you how much profit they made in dollar terms, but from my experience, what they can't tell you is how much capital they had tied up in the business.

This simple ratio is an all-encompassing measure of financial performance and should be the first ratio business owners ask for from their financial advisor.

After thirty years advising small business owners, its still surprising to see that many dont read the signs and seek help early enough. Many even end up using the ATO as a banker to fund their growth.

The key is to surround yourself with competent financial expertise, know what questions to ask and make sure you have appropriate financial reporting systems in place to ensure you receive accurate, timely financial information.

Here are some key indicators to determine if you're receiving adequate financial advice about your cash flow situation:
  • Most businesses don't take into account that growth for growths sake is not always the best thing for the business. High growth means high risk and businesses need to surround themselves with competent financial expertise to manage that risk.
  • If your financial team can't tell you what your free cash flow is, they shouldn't be there. No matter how profitable your business, you can still have negative free cash flow. This means that even if you're making a profit, your business is growing at such a rate that the profit is not sufficient to fund the growth. This means having to borrow more and more from the bank until there's a hiccup and the bank says no more.
  • Know your Sustainable Growth Rate. How much can the business afford to grow without requiring disproportionate debt? Your financial team should be able to tell you what this is. Growth funded entirely on debt is dangerous growth.
  • Know your working capital absorption ratio. This is a simple ratio that you particularly need to know in a high growth business.  In other words, how much additional working capital is needed to fund a given increase in turnover?
  • Another key reason why businesses don't have cash is that they are not profitable. It doesn't have a cash flow problem; it has a profitability problem. It may have a history of prior losses as well as the current year. These losses have to be funded from somewhere and that is usually from the shareholders, or more likely, the bank. Ultimately there comes a time when the bank says no more.

Author: Grant Field
About: Grant Field is chairman of MGI Australasia and has operated an accountancy practice in Brisbane for 30 years specialising in family businesses.

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