Insolvency firms were expected to have a stellar year. However, the Federal temporary debt and rent relief programs have put the kibosh on anticipated business failures. Ironically, the majority of insolvency firms are struggling to survive. Whilst grim satisfaction may be an initial reaction, such relief programs may actually worsen the health of the economy.
The adage: “Capitalism without bankruptcy is like Christianity without hell” remain a truism irrespective of economic climates.
These programs will eventually expire (possibly by end September). Subsequently, industry experts expect a tsunami of winding up applications and a spike in demand for debt collections. Evidence from Australian courts have shown a 64% y-o-y reduction in wind up applications for the Apr-Jun quarter. This has been accompanied by debt collection agencies reporting a substantial slow down in activity over the same period.
Further signs of a deteriorating economy has been increased loan loss provisions by the major banks and the rise in provisions for doubtful debts by corporations. Consumer facing businesses as diverse as AGL and Breville have recently ratcheted up their provision for bad and doubtful debts.
As such, now is a timely moment to check in on your cash preservation initiatives.
Managing customer credit risk is one important control during these times. Assigning credit ratings to your customers, avoiding trade credit issuance, assessing the trade-off between credit risk and a marginal sale, reducing concentration risk and KPIs which are aligned to sales need reviewing. Even for e-commerce platforms, it is worth keeping an eye on chargebacks and returns.
Working capital management is an equally important process.
Nearly 40% of small businesses report significant cash flow pressures due to late payments. This was prior to the COVID-19 pandemic which has only exacerbated tightening of cash flows. Also highlighted by the Australian Small Business and Family Ombudsman, 53% of invoices are paid late by large to small businesses. This equates to $115bn in delayed earnings and $7bn of working capital not being available.
As a mitigant, businesses should be adjusting their payment plans inclusive of incentives for early and upfront payments, deposits for scheduled services and rebundling of product packages can partially circumnavigate losses and slow payments. As well, standard practices such as debtor ageing and DSO analyses on an increased cadence can ameliorate a rise in provisioning.
One ugly aspect of a deteriorating economy is the rise in fraud. In 2018, fraud already accounted for $3.3bn in costs within retail Australia. Supply chain accounting accounts for more than one-third of such fraud. Auditing your loss prevention systems will be an important process to ensure your losses are as low as possible. A regular feedback cadence in relation to customer purchasing patterns (offline and online), detection methodologies and cost savings aligned against measurable and realistic targets will be an essential tool.
Moreover, it pays to be mindful of the ancient art of fake invoices. It is allegedly the second invention after paper. The Economist believes that 2020 will be a banner year for invoice fraud. The recent downfall of major corporations such as NMC Health highlighted the dangers of issuing credit based upon forged invoices. Credit insurance will provide protection against forgeries though not against multiplied use of the same invoice to different vendors.
In relation to inventory, conventional wisdom is to reduce to free up capital. Certainly in past recessions, that rule held across the board. However, this current crisis is somewhat unique in that customer demand has not subsided. Rather it has been involuntarily suppressed due to imposed shutdowns across the supply chain. Hence, reducing inventory would be applicable for certain sectors such as oil production, the same could not be said for bicycle manufacturers.
Working capital management is a critical element of maximising a business’ liquidity. Along with assessing customer credit risk, reviewing one’s financial structure and access to funding, they are all aimed to ensure optimal maintenance of cash reserves to position your business stronger through and after the economic downturn.
Maximising your cash flows can be a thankless and grim exercise. Having said that, imagine yourself 18 months from now and your business has gone bankrupt. What are the top 5 things you wished you had done to avoid such an outcome ?
