Risk Management focus

29/10/2008

With the banking sector reeling from an apparent lack of risk management, the financial risk management strategies of manufacturers are also being put to the test. With high energy costs, a slowing economy and a general lack of available credit, how many businesses are sufficiently prepared to trade through if cash flow pressures start to bite?

Stephen Fern, director at LC Corporate Strategies, looks at the options available to manufacturers when trouble hits; from ring-fencing VAT and PAYE arrears, to realising the value in the balance sheet, what steps should managers be taking to secure the business for the future?

Risk management is about identifying the threats to a company's profitability or survival and planning a strategy that will minimise or eliminate their effects. Risk management has many connotations and applications. We are currently experiencing the aftermath of a lack of risk management in the financial sector, and are likely to continue feeling the impact of the resultant banking crisis into 2010.

Clearly risk management concerning health and safety and data security remain top of the agenda for manufacturers regardless of the state of the economy. Financial risk management however is all too easy to push aside when times are good. Consumers that leveraged themselves to their full extent to buy property at the market's peak are now finding themselves in a precarious position as energy prices and the cost of borrowing have increased, while property values have tumbled. In the same way, some businesses took greater risks to facilitate ambitious growth plans during the boom, and are now struggling with additional premises, equipment and labour costs as we move into a tougher trading period.

The recent economic prosperity in the UK has largely been fuelled by easily available credit. Credit has significantly dried up, and in the majority of cases, the absence of consumers with healthy savings accounts and businesses with a good supply of working capital is having a negative effect on spending in the wider economy.

Economic data pouring into the media on the state of the manufacturing sector in the UK emphasizes a bleak future in the short term. What can managers of businesses in this sector do now to ensure they are best placed to secure the future of the company and its employees and what actions should be taken in the future to better manage cash flow risks?

Firstly, there are a number of warning signs that can be indicative of more serious underlying issues within a business when combined with macroeconomic pressures which can jeopardise a company's stability. These are:

Gaps in financial information and slipping budgetary controls
A significant drop in working capital
A lack of cost controls
Increasing overdraft & finance charges
Deferred or delayed VAT and PAYE payments
Unhealthy dependence on a small number of customers or suppliers
Production disruptions or delays
Poor staff retention
Loss of key customers and increasing aged debt
Disputes among directors and senior managers
Deteriorating relationship with funders

At different times most businesses will experience one of these factors. But a combination of these factors over a sustained period is a signal that the business has underlying issues. Owner managers when confronted with these challenges can spread themselves too thinly, ‘fire fighting', in a bid to resolve the company's current predicament. This can result in unresolved issues escalating and managements' key skills not being maximised.

Difficult though it may be, managers must try and take a step back and view the issues affecting the business from an operational point of view. . There are immediate actions that can be taken to alleviate some of the pressure. Firstly, cash flow controls need to be tightened. Analyse the company's cost base and identify areas where the business can rationalise expenditure. This could involve renegotiating rent payments with the landlord or agreeing extended payment terms with suppliers. Unfortunately it may also include cutting human capital. If plants must be closed and redundancies made, hard though it is, these decisions must be made quickly to safeguard the future of the business.

Secondly, don't ignore your funder, whether bank or asset based lender. It is far better to confront financial performance issues rather than wait until you are unable to pay them. However, a word of caution - be prepared. The banking crisis has made lenders more risk aware, and lending criterion has become far more stringent and in many cases more costly. Make sure accounts are up to date, that there is a robust forecast available and evidence of a strong management team. There are still financial institutions willing to lend, and asset based finance in particular is a cost effective way for manufacturers to make the balance sheet work for the business. It is also more popular than providing pure credit at the moment, as funders prefer to lend according to the assets of a company rather than extending cash overdrafts or loans.

The next step is to analyse the business' core operations;

Is there a healthy pipeline of new customers?
Is there long-term demand for a particular product?
Are we focusing on higher margin work?
Can improvements be made to manufacturing processes?

Strategically assessing the business will identify its weak points, be they process or people driven, and enable you to determine the best path forward for the company. Where gaps in performance or skills are found, consider getting outside help. Bodies such as the Manufacturing Advisory Service (MAS) are able to advise on manufacturing best practice, from the latest technologies to six-sigma. If a skill gap exists it may be beneficial to employe the services of an interim manager. We maintain a database of interim managers with a broad range of skills. This can be particularly useful if the prospect of preparing financial information and business plans now necessary to successfully apply for funding seems daunting. Many accounting firms also provide quasi FD services with preparation and analysis of management accounts at a cost far less than that of appointing a full time employee in such a capacity.

Other options for the business include working with Her Majesty's Revenue & Customs (HMRC) to renegotiate VAT and PAYE arrears on behalf of companies. Where a business can demonstrate long-term viability and provide robust financial information, it is possible to ring-fence any Crown debt and agree a time-to-pay arrangement with HMRC. This immediately frees up cash flow and gives managers some much needed breathing space.

It's also important not to get too disenchanted with the current economic climate. As I write the value of the pound is falling, but for exporters that can only be a good thing. A recession can force some tough, but necessary, decisions. Whilst the economy is growing and times are good it can be easy for companies to overlook inefficient practices and ignore underperforming staff. When times are hard, this cannot be ignored and must be addressed. Addressing such issues is a positive move and will leave companies leaner and stronger to negotiate the current economic downturn. There is every chance for a strong, well capitalised business to increase their market share during a downturn, whether through opportunistic acquisition or an improved offering. With the right advice, it is very possible to turnaround a struggling company's fortunes.

Many managers and directors are beginning to feel the effects of a recession. If a business is not prepared today, it does not mean steps cannot be taken to prepare it for tomorrow. If you find yourself with some of the warning signs discussed earlier or require general advice, do not delay. The earlier help is sought, the more chance there is a solution can be found.

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