It seems the Elephant that is 'cash outflows cannot exceed cash inflows' is well and truly in the room.
 
 
It seems the Elephant that is 'cash outflows cannot exceed cash inflows' is well and truly in the room.

Funding your future

Recent high profile failures in the legal sector are likely to mean that for firms with less than healthy finances, the ability to raise short term finance is likely to be very restricted.


Peter Gamson

Peter Gamson

Peter is an audit partner in London and Head of Grant Thornton's national Professional Practices group. His focus is on advising Professional Service firms with clients across the legal, consulting, surveying, accounting, architectural, consulting engineering and patent attorney sectors.
Peter Gamson

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Introduction from Executive Producer CHRISTIAN ROELOFS

Many firms have found themselves in financial difficulty and as we know lending from banks has fallen sharply since the financial crisis – and has not been replaced by alternative sources of finance. This piece from Grant Thornton's Peter Gamson and David Dunckley look at one specific sector – professional service firms – and the difficulties they may have when they run into cashflow problems. As they say, banks are looking much more closely at firms who fail to control their cashflow, and who continue to put partner drawings and profit distributions above other commitments. The advice is to address the problems early, and address the fundamental ones.

Who should be interested in this?
Directors of professional services firms, and other smaller businesses, who are facing cashflow challenges.

 

Funding your future 

Grant Thornton has been highlighting the heavily geared balance sheets of many professional service firms for a good few years now, highlighting that in tough times, it is less than ideal if you are having to rely on external funding, or indeed the permission of the providers of external funding, to execute key decisions for the firm. The current climate certainly represents tough times for many and right now, the end doesn't appear to be obviously in sight. It seems the Elephant that is ‘cash outflows cannot exceed cash inflows' is well and truly in the room. For many there is no way of continuing to ignore it.

Recent high profile failures in the legal sector are likely to mean that for firms with less than healthy finances, the ability to raise short term finance is likely to be very restricted.

Halliwells and Dewey LeBoeuf were high profile but in their own way, able to be considered isolated incidents in a market that, whilst struggling, was still surviving. Then came the first quarter of 2013; whilst Cobbetts was by far the largest firm to find itself in difficulty, the highly publicised demise of Semple Fraser in Scotland, and Blakemores in Birmingham have caused the banks to once again increase the focus on the ability of their clients to service their debt.

When July tax payments are approaching, and with this quickly followed by the annual PI renewal process (premiums due in September), many firms will find their cashflow forecasts under strain and find themselves in a position where they will be seeking additional finance to smooth out these significant cash outflows.

At a headline level, there are two primary routes to take but both may well present more of a challenge than in previous years.

The banks have now had their fingers burnt a fair few times over the past few years and will be reluctant to extend overdrafts or provide short term facilities to firms whose balance sheet and cashflow forecasts don’t inspire confidence. Our expectation is that simple extensions of the overdraft may be unlikely for those who have habitually borrowed to cover these payments and that rates and conditions applied may be more severe than in the past. We also think there is a high chance of refusal as the banks are rapidly losing their enthusiasm to continue to fund firms who show no signs of controlling their cashflow around the commitments of the business, and who continue to put partner drawings and profit distributions above other commitments.

Which brings us to the secondary lenders. All of you are used to receiving calls and emails from a raft of secondary lenders around this time of year, offering short term funds that allow you to spread the cash impact of the tax and PI payments over a period of a few months to a year. Whilst we expect the number of phone calls to continue to be high, I believe the number of serious offers that will come out of the conversations that may follow will be much reduced. The secondary lenders are beginning to see that for firms in financial difficulty, the likely exit plan will involve a pre pack administration. In cases where the primary lender is significantly underwater at the time of the pre pack, the secondary lender is not going to have the chance to be around the table and part of the administration discussions, and therefore has no control over the destiny of the firm, and very little chance of seeing anything other than a very low return on their lending. This makes for a poor prospect when these lenders seek to get any funding through their credit teams and we anticipate a far higher instance of firms being refused credit right when they need it.

It has been relatively common in the past few years for firms to rely on this sort of additional funding. In some cases where the cash forecasting is perhaps not as rigorous as it should be, or where significant adverse debtor collections have not been easy to predict, some firms have made a habit of only seeking short term funding in the last few weeks before the payment is due.

Our view in the current market is that leaving any conversation with a bank or secondary lender until late in the day is likely to lead to at best, high rates and unfavourable terms, and at worst, an inability to raise funds in time. In a perfect world, the lender would want sufficient notice so as to be able to put the application through their credit teams well in advance, and to have the facility lined up on a timely basis. A potential borrower who is looking ahead at cashflows and proactively managing the funding requirement through early dialogue is always going to find themselves in a better position than those who appear to have been ‘surprised' by the cash shortfall right at the last.

The current climate is though, far from a perfect world and for those not showing a strong awareness of short and medium term forecast cashflow, a balance sheet that has the underlying strength to indicate that the loan can be repaid and an approach to running the business that is focused on managing profits and cash rather than simply on extracting cash out of the business into the hands of the partners, we believe the coming months could be very tough to navigate. For some – it will be fatal.

So what can you do to manage this risk?

Firstly – enter into timely, and detailed, dialogue with your main lenders. Provide them with robustly prepared management information and forecasts and be prepared to discuss the business in detail with them. Give them confidence over your business model and your approach to running that business and show them how you forecast that their money will be able to be repaid within a sensible timescale. This type of borrowing isn't about investing in the future activities of the firm, it is simply about bridging a cashflow shortfall in order to allow the business to continue. It therefore isn't something that the lender would be happy to see being spread over anything other than the relative short term and certainly isn't something that any bank will want to ‘add to the facility level' each year.

Secondly – address the issues that are causing the underlying cash shortage. For most firms this is likely to be that more is being paid in terms of employment costs and partner drawings than the operational cashflows of the business can support. Reducing headcount may be the medium to long term answer for some but in the short term, most lenders would wish to understand that partners have recognised the need to reduce their drawings for the sake of the business' survival.

Thirdly – assess whether your firm is adequately funded by the stakeholders. The sector continues to be significantly ‘under-capitalised' by reference to other comparable sized businesses outside the sector and the banks' and other lenders' appetite for continuing to fund when the owners of the business are not committing significant amounts of their own capital will become increasingly limited going forward.

We have significant experience of assisting firms in preparing and presenting their cashflow to the bank, and assisting in addressing situations where businesses are underfunded or underperforming. If addressed at an early enough stage, most situations can be managed successfully.

What we would never wish you to do is risk the future of the firm by not taking positive steps to manage the situation. Leaving it to the last and hoping for a favourable outcome has always been risky, but in the current climate, it feels like a risk too far.

If your cash position looks grey, has four legs and a somewhat long, nose-like, appendage, it may well need to be time to acknowledge that the elephant exists. Otherwise the banks and secondary lenders may well be pointing it out.

About Grant Thornon

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This article was originally published by Grant Thornton UK LLP under the title ‘Funding Your Future' © 2012 Grant Thornton UK LLP. All rights reserved. ‘Grant Thornton’ means Grant Thornton UK LLP, a limited liability partnership. Grant Thornton UK LLP is a member firm within Grant Thornton International Ltd (‘Grant Thornton International’). Grant Thornton International and the member firms are not a worldwide partnership. Services are delivered by the member firms independently. This publication has been prepared only as a guide. No responsibility can be accepted by us for loss occasioned to any person acting or refraining from acting as a result of any material in this publication.

 

CC BY 4.0 Funding your future by Peter Gamson is licensed under a Creative Commons Attribution 4.0 International License.