Using Your Assets to Fund Cash Flow in a Turnaround

When a business is in trouble, the overdraft is usually the first thing to run out and the last thing the bank wants to extend. Most owner-managed manufacturers, though, are sitting on assets that can raise cash: money owed by customers, machines on the shop floor, stock in the stores and, sometimes, the building itself. Used carefully, these can buy the time a turnaround needs. Used carelessly, they add cost and risk to a business that already has plenty of both.

The four main tools

Invoice finance. A lender advances a share of the value of your sales invoices as soon as they are raised, rather than you waiting for the customer to pay. With invoice discounting you keep control of collecting the debt and customers usually do not know. With factoring, the lender runs your sales ledger and collects the money. Discounting is cheaper and more discreet, but lenders tend to offer it only to businesses with good credit control already in place.

Asset refinance. If you own machinery outright, or have paid down most of a finance agreement, a lender can advance money against it. The machine stays where it is and keeps working. The amount depends on what the lender thinks the machine would fetch if it had to be sold, which is usually well below what you paid for it.

Asset-based lending. This combines several asset classes, typically debtors, stock, plant and sometimes property, into one facility. The amount available moves with the value of the assets, so it can grow as the business recovers. It suits businesses with a reasonable spread of assets and the reporting discipline to keep the lender informed.

Sale and leaseback. You sell an asset, often the property, to an investor and lease it back. It can release a large sum in one go. You give up ownership and take on a long-term rent commitment, so it needs careful thought about whether the business can carry that cost once the crisis has passed.

What lenders look for

Asset lenders are less interested in your profit history than a bank would be, but they are far from careless. Their questions usually fall into a few areas.

• The quality of the debtor book. Who owes you money, how old the debts are, and how much is concentrated in one or two customers. Disputed invoices, credit notes, stage payments and customers who are also suppliers all reduce what a lender will advance.
• The real value of plant. Lenders will usually commission their own valuation, based on what the equipment would raise in a sale, not on its book value or replacement cost. Specialist tooling made for one customer may be worth very little to anyone else.
• Stock that can actually be sold. Raw material is easier to lend against than work in progress. Obsolete or slow-moving stock may count for nothing.
• The information you can produce. Accurate aged debtor reports, stock records and monthly management accounts, produced on time. If your systems cannot do this, fix that first. Our piece on turning data into information covers the basics.
• A credible plan. Even an asset lender wants to see how the business gets back to generating cash. A facility that only delays failure is no use to them.

The risks

Asset finance will not rescue a business by itself. The main risks are worth stating plainly.

Cost. These facilities are usually more expensive than a conventional overdraft once fees, interest and audit charges are added up. Ask for the total cost over a realistic period, not just the headline rate.

Dependence on the debtor book. With invoice finance, cash available falls when sales fall. In a downturn the facility can shrink at exactly the moment you need it most.

Personal guarantees. Many lenders ask directors for personal guarantees. Understand exactly what you are signing and take independent legal advice before you do.

Directors' duties. If a company is insolvent or close to it, directors must give proper weight to the interests of creditors. Raising secured finance at that point needs care, and advice from a solicitor or licensed insolvency practitioner. Our guide to restructuring and insolvency options sets out the wider choices.

Losing flexibility. Every asset pledged to one lender is an asset you cannot offer to another.

Getting it right

The businesses that use asset finance well tend to do a few things in the same order. They build a short-term cash flow forecast first, so they know how much they need and for how long. They clean up the debtor book, chasing old debts and resolving disputes, before a lender looks at it. They get an honest view of what their plant and stock are worth. And they approach more than one lender, because terms vary widely and the first offer is rarely the best.

They also treat the money as time bought to fix the underlying problem, and they use that time. If you have not yet got control of the weekly cash position, start with our piece on managing cash flow in a turnaround.

We help owner-managers work out which assets can raise cash, prepare the information lenders need, and introduce them to lenders in our finance sector network. If you are facing a cash squeeze, read more about our turnaround services or get in touch.