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Case Studies
- Ignorance can not be excused
- Malcolm Fraser once said “life wasn’t meant to be
easy” and for many directors the task of running a
company has not been a “walk in the park”.
Besides the challenges of running a successful business
in a competitive marketplace, directors need to be aware
of the company’s trading performance and whether matters
of compliance are being completed.
Four years after the introduction of GST, we are now
starting to see companies experiencing cash flow
difficulties. These difficulties are often caused by:
• poor strategic decision making
• poor cash flow projections
• inadequate reporting
• inability to meet GST, PAYG Withholding and PAYG
Instalment obligations.
The problem…
Company ABC recently contacted AW Munro & Co, concerned
about a substantial debt with the Australian Taxation
Office (ATO), which comprised GST, PAYG Withholding and
a Superannuation Guarantee Charge.
They had successfully arranged a repayment program with
the ATO, however, to meet this program, trade creditor
days were increased and the company’s banker paid closer
attention to the overdraft while also requesting
increased reporting of trading results.
To frustrate matters further, the company’s part-time
bookkeeper resigned and the replacement bookkeeper
discovered fundamental accounting problems which
required extra work and expense. Also, there were ever
increasing interest amounts on unpaid taxes and
penalties for late lodgement of BAS forms. The company
was in a mess and the directors had allowed the company
to trade on because the company was still making sales.
Were the directors allowing the company to trade while
insolvent?
Frankly, we were concerned for the directors who were
personally liable for the PAYG Withholding charges that
had not been paid, and for any debts incurred by the
company which continued trading while insolvent.
The solution…
One of the first steps on the road to enlightenment for
Client ABC is a financial health assessment. This
involves assessing a number of factors including a
company’s:
• operating profitability
• sustainable growth
• productivity of capital employed
• activity drivers for value creation
• return on capital employed
• marginal and net cash flows.
After the initial health assessment we then work with
the company’s directors and management to develop
budgets and cash forecasts and to make strategic
decisions. The resulting plan is not cast in concrete;
it is monitored and adjusted as the company goes about
its business.
Most importantly, the directors have the necessary
information to ensure that the company does not trade
while insolvent.
With regard to Company ABC who was experiencing the
problems outlined above, it is still trading and we are
working with them to manage their financial issues. The
one thing that is certain is that the difficulties being
encountered could have been avoided if the client had
come to the realisation that help was needed and advised
us earlier about the company’s circumstances.
- Cash flow vs. profitability
- Recently, AW Munro & Co were asked for advice from a
large retail client about establishing a new store in
their existing chain. The proposed new store was a
quantum leap in terms of size for the group.
The problem…
The client had thought the new venture through, coming
up with a number of strategies for the new store
including a projected cash flow summarising the expected
results for the first five years of trading. The cash
flow projection showed that the client required
approximately $100,000 in funding.
After discussing the proposed store with the client in
some detail and gathering all the necessary information
including the cash flow projection and information on
projected sales and expenses to give suitable
recommendations, AW Munro & Co found the following:
• The new store appeared to have the potential to be
profitable.
• The value of the business after the first five years
could be approximately $750,000.
• The estimated return on investment was acceptable
(about 25 per cent per annum).
• Finally, the AW Munro & Co analysis revealed that
based on the figures provided by the client, an
estimated $300,000 would be required to fund the growth
of the new store.
Not surprisingly, the client was alarmed to learn that
they would need $300,000 to sufficiently implement the
strategies and grow their business.
The solution…
The cash flow projection told only half the story. A
typical cash flow projection only focuses on sales and
expenses. A comprehensive analysis like the one AW Munro
& Co performed looks at a whole range of other
influencing factors.
These other factors included the following:
• level of stock and debtors and creditors, taxation
implications
• distribution of profits to the owner
• debt reduction.
As the projected level of sales for the new store
increased each year, AW Munro & Co advised that
additional funding would be required to finance the
rising levels of inventory and debtors.
After further discussions with the client and a group
meeting to change some of the information provided to
more accurately reflect the new store projections, AW
Munro & Co was able to reduce the anticipated level of
funding to $175,000.
The recommendations that AW Munro & Co made to reduce
this figure included the following tips to improve cash
flow and increase profitability:
• improving stock turnover
• shortening credit terms to customers
• negotiating more favourable terms with suppliers
Six months after opening, the store is achieving sales
targets and is profitable. And more importantly, it has
sufficient cash to operate and grow.
- Financial health assessment
- Our business is growing. We are increasing turnover,
but reducing cash flow. Why?
This seems to be a common problem in small to medium
businesses, and without a proper assessment and the
right advice, it can cost you your business.
Recently Company XYZ approached AW Munro & Co with this
problem.
They ran a retail business which they established about
four years ago. The client contributed about $350,000 to
fund the set-up of the business.
The problem…
They were experiencing cash flow problems and the owner
had reduced his fortnightly salary to fund the
shortfall. They had employed more staff to meet customer
demand; however, the owner’s own salary was now less.
Confused and frustrated with the situation, the client
was advised by AW Munro & Co to undergo a financial
health assessment. AW Munro & Co reviewed the current
and previous years’ results and found several key issues
which would affect cash flow:
• Sales had doubled over the past four years.
• Ageing of stock was over 150 days.
• Creditors were being paid within 30 days.
• Gross Profit Margin was only 25% compared to the
industry average of 40%.
• Staff were being rewarded based on sales targets,
irrespective of the profit margin.
• Return on investment was less than 5% pa.
The solution…
AW Munro made the following recommendations:
• Reduce the ageing of stock to a more acceptable level
of say 90 days. This would free-up approximately $50,000
cash each month.
• Perform a detailed review of the sales mix and
identify the profitability of each product line.
• Increase prices by 15% over a 12 to 18 month period.
Although the client expected that the sales volume could
fall by some 10%, the projections showed that the
financial position would actually improve.
• Devise an incentive plan to reward employees based on
real profit, not sales targets. Real profit is
calculated after taking into account a return on the
investment to the business owner.
• Finance the business assets under a sale and leaseback
arrangement to provide cash to fund the growth of the
business.
• Prepare the following budgets to plan the future of
the business based the financial health assessment:
a) Cash Flow Projection
b) Profit & Loss Statement
c) Balance Sheet
- Get a valuation and remove the emotion
- Whether you are looking to buy or sell a business,
or are even dividing assets in a divorce settlement, an
independent valuation by an experienced and objective
valuer can ensure the asking price is reasonable and
justified.
The problem…
Recently, AW Munro & Co received a call from a client
who had just accepted a redundancy payout and was
considering buying a cafeteria for $200,000. Excited
about the new venture, the client said based on
financial statements supplied to him by the vendor, he
would obtain a 30% return on his investment.
To ensure the asking price was fair and reasonable, the
client asked AW Munro & Co to value the business
independently.
The solution…
As a result of a thorough review and valuation, AW Munro
& Co discovered that the fair value of the business was
only $50,000 – simply the value of stock and plant and
equipment.
Based on our review, a number of significant adjustments
were required to arrive at a realistic level of profit.
The financial statements did not include commercial
wages paid to the owner and his wife. Both the husband
and wife were working six days a week, 14 hours a day,
but had only drawn a combined wage of $20,000.
After adjusting the figures, the business was not
capable of making a real profit, and only had a value
equal to the stock and plant and equipment of $50,000,
compared to the asking price of $200,000. The client was
actually spending his redundancy payment of $200,000 to
buy himself a job.
The client consequently did not buy the business.
Instead, he invested the money in a superannuation fund
which is now generating on average 10% per year.
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