One of the most important processes any company can initiate, particularly in a period of uncertainty, is to formulate an understanding of the financial resources available to its operations. The first step is to have historical financial statements audited by a reputable accounting firm. Not only will this permit owners to inspect the efficiency of current operations and cash flows, but the statements are a prerequisite to securing financing or initiating an M&A transaction: corporate lenders or possible buyers will insist on audited financials before a transaction is consummated.
An essential aspect of maintaining strong internal cash flow is the diligent tracking of working capital, especially accounts receivable, accounts payable and inventory. On the receivables side, by monitoring billing and aging policies and assuring that sales are turned into cash quickly, a business should be able to spot credit issues among its customers and avoid borrowing funds to meet working capital needs. Accounts payable can be used as short-term financing, although it is critical to avoid vendor issues that can turn into major credit problems.
Tight controls on inventory will also assist in securing adequate working capital. An examination of a company’s inventory turnover ratio reveals how quickly and efficiently companies are moving product from inventory into sales (cash), and can be used as a valuable tool in predicting future cash flows. Broadly speaking, a high inventory turnover is good, as it shows a business is moving product off the shelves quickly and often, while a low ratio would indicate that product is remaining in inventory for long periods of time where it does not make money. High inventory levels are of concern, as they represent an investment with a rate-of-return of zero, and also potential losses due to obsolescence or shifts in demand.
If strong free cash flows exist, companies should consider paying down existing debt (beginning with high-cost and short-term debt), as some lenders may be looking to tighten covenants. While commercial lenders may deny any “formal” changes to the standards by which investment is made or credit granted, credit criteria have tightened in terms of credit strength required from borrowers. Debt should continue to be available for well-run small and medium-sized companies with attractive profiles, strong positions in niche markets and good management teams that can react more quickly than larger companies. Even companies in good standing with defendable growth prospects may find themselves with cumbersome debt arrangements and should now attempt to take advantage of their good credit to restructure undesirable debt instruments.
Preparing for the future
The sector can best position itself for the future by focusing on internal controls and maximizing its own value. For companies that are showing strong growth, have major upcoming capital expenditures or are perhaps faltering, it is critical to act now instead of later. Many of the above suggestions can be handled internally by competent management teams, but for event-driven strategic moves such as discerning proper acquisition targets and possible interested buyers, or negotiating with current financial partners concerning covenants or future lending, companies should look to obtain experienced advisors. As large strategic buyers look for acquisitions that once went to cash-rich private equity buyers, and as lenders look for companies with good credit as a safe harbor, small automation companies may be the most attractive ports in the storm.
Charles Carson, CCarson@CronusPartners.com, is a Managing Director of Cronus Partners LLC, www.CronusPartners.com, an investment banking firm specializing in automation technology.
Nothing contained in this article is to be considered the rendering of financial, investment or professional advice for specific circumstances. Readers are responsible for obtaining such advice from professional advisors and are encouraged to do so.