The Cash flow implications of jumping on opportunities.
Entrepreneurs and small business owners often need to act quickly to jump on an opportunity before they miss it.
The danger is that even if the margin and potential profit all make good business sense, without fully understanding the cash impact of taking on the opportunity, you could be putting your entire business at risk.
We’re not saying you shouldn’t act quickly, but we are saying it’s important to understand the cash impact of every decision, no matter how profitable you know it to be.
An excellent example of this happened just last week.
A large listed multi-national company (MNC) approached our client offering a deal where our client was to procure goods for them at a margin of 10%, but with very little involvement required by our client.
This was to be a very low administrative model whereby our client would merely receive a request for a specific piece of equipment, from a specific supplier, which was to be ordered and delivered directly to the MNC. Our client would buy direct from the wholesaler before on-selling to the MNC taking a 10% margin for their efforts.
Our client is currently funding growth in their normal business operations so there is less cash available than there normally would be.
Apart from the obvious risks associated with being the middleman for this type of transaction, our client would also carry the additional cash flow impost of having to fund the purchase up front from their wholesale supplier, whilst being paid 60days from their MNC customer.
This means our client was having to fund the entire purchase themselves for at least a period of 60days before they would be paid by their customer.
With no additional overheads, a 10% return for 60days with very little involvement is enticing.
The Cash Impact:
In these circumstances, most of the wholesale suppliers would need to be paid in full up front before supplying the goods.
Our client would receive their payment on strict 60 day payment terms from their MCN customer, meaning they would have to fund the purchase for at least 60 days.
A 10% return for 60days investment equates to a 60% return per annum.
Our client would need to fund 100% of the cost of the requested equipment from their normal operating cash flow for a minimum period of 60 days, to receive only a 10% return on this sale of goods.
This means, their normal business operation could be cash-starved and put at risk if he is to accept the opportunity.
We worked through several funding options with our client, taking into account the effect of each on his normal operating cash flow, as well as taking into account any additional cost of capital as required.
Funding options considered included:
- Funding from existing operating capital (cash);
- Funding from existing Debtor Finance facility (debt);
- Funding from separate deals using our network of short-term investors (debt);
- Funding from various other sources etc.
From all the options considered, there were clear frontrunners and clear losers; and whilst this is still a case in progress, after analysing the front runners the solution at present includes formulating a model whereby procurement deals can be individually assessed and undertaken on a case by case basis at an agreed % margin (often higher than 10%).
Due to the lumpy nature of the potential transactions and the varying dollar amount required for each (currently ranging from $10K to $100K), it’s imperative our client has full control over when they can and can’t afford to take on an individual procurement deal.
Funding these deals independent of the main operating business is the preferred option at present. This will likely mean utilising our network of short-term investors, or another source of short-term funding, noting that both of these will have a cost attached to them, but will also mean there will be nil impact on the cash flow of the existing business operations.
- Don’t cannibalise you’re existing business to jump on a new opportunity (unless your existing model needs fixing).
- The opportunity can work under the right conditions, but it must not affect the core business operations and must be able to be declined if required.
- Ensure the risks are understood, including all the normal risks associated with procurement transactions, as well as those hidden ones that may not be so obvious.