There is no doubt that there is a trend towards ‘sustainability’ for many businesses across many industries. But it is important to understand what we mean when we use that term.
The most obvious interpretation is to aim for your business to have a ‘net neutral’ impact on the planet. Carbon neutral products and processes, recyclable materials etc. This may also capture aspects such as so called ‘fast fashion’, i.e. avoiding products with short lives so that whatever the impact, it is spread over a longer useful life. The shift from technology and white goods that are scrapped when they break, to ones which are designed to be easily repairable.
As accountants, that sort of stuff is not really what we do. However, there will be a time when we are required to report in the accounts of all businesses on their ‘impact’ or sustainability credentials.
Let’s just consider for a moment ‘financial sustainability’.
Every business will see money in from sales and money out from purchases and overheads. What’s left might be subject to tax, and the withdrawal of income by owners. Like any other processes, the objective is to cut waste and inefficiency. To require less borrowed cash to run the business.
This splits into two aspects…
Increasing incomes and reducing costs, i.e. making more money
Controlling the amount of cash tied up in the business in debtors, stock or other assets.
The object of the exercise is to make any business as self-sufficient as possible and less reliant on outside money with all the risks and costs that that entails.
Many businesses have become used to a low interest rate regime, with easy and fast access to debt. A side effect of low cost debt is that the drive for high profits and strong cash reserves became less important, because there would always be a quick fix if needed. Businesses would drop prices, shop around less, and spend more than needed, because they had confidence they could borrow to fix any glitches that cropped up. In short, many just got a little lazy in the financial drive of the business. That doesn’t mean they were profitable, they just didn’t work as hard to manage profits and cash as they could have.
Moving forward we have already seen interest rate increases, supply chain problems and now rapid inflation and soaring energy costs. For any business to be sustainable in the current economy, there will need to be a greater focus on the bottom line and on building cash reserves to ride out any rough patches. Whilst all Banks have plenty of money to lend right now, they will inevitably get more cautious about who they lend it to.
So what should you do?
Maximise profitability.
This starts with selling in the right way, to the right customers, and most importantly, at the right price. In an inflationary market selling skills become much more important, negotiating prices, payment terms and working with the right quality customers become critical issues.
Making sure all costs are controlled is also important. Many make the mistake of searching for the cheapest service/product, when the objective should always be Value for Money. A balance of quality, price and service. What’s the point in buying cheap products if they always break, or in paying rock bottom for services if people don’t turn up on time and do what they say?
However, the clear objective is to understand the current financial performance of the business and look for all the places that profit leaks out. It is always amazing to us how relatively small changes in prices, costs of sales and overheads, can have the impact of doubling or trebling bottom line profits.
In our experience, this process requires a deliberate ‘project’ approach. Get the date, involve the right team, do the thinking and agree the actions. Set deadlines and responsibilities to implement changes. Just saying “Let’s be tougher on prices and costs” won’t make any real difference.
Manage money better.
The 10 years or so pre Covid have been a steady and relatively easy economy. Most customers paid, so debt collection became quite passive. Money was easy to borrow, so few bothered with a cash flow forecast because the Bank (or someone else) would cover a short term glitch or a bigger than expected tax bill for example.
As we enter a more volatile economy, not everyone will pay on time, or at all! You should ensure you have robust credit control procedures (don’t even sell to dodgy customers) and better debt collection processes (chase fast and chase hard).
Always borrow appropriately. Many got into the habit of saying, “we have spare cash so don’t buy that machine on finance”. But once cash is locked up in the asset it may be hard to get back if needed. As a broad rule of thumb…
Buildings on 15 to 25 year mortgages
Plant, equipment and machinery on 5 to 15 year terms depending on the life of the asset.
IT stuff, 3 to 5 year funding.
Over the next 5 or more years, cash in your account will be more valuable than saving a few quid on interest costs.
Let’s also tackle an issue we see across many clients. For most businesses, times were quite good pre Covid. In fact many have made more money during Covid than they did before. High profits and a (Comparatively) low tax regime have meant that many business owners were able to extract more cash over that period.
Many bought bigger houses, nicer cars, grander holidays, and got used to an expensive lifestyle they didn’t really need. Ok if the money is there, client’s choice to spend now or save for the future. However, what we have seen in previous recessions, is that many ‘high spenders’ resist any reduction in their lifestyle when profits and incomes drop. The switch from enough money to enjoy this ‘extravagant’ lifestyle and have a little left over, to spending more than you make and running up credit cards, loans and overdrafts, is a very fine line. Try ringing the Bank from your luxury holiday in Dubai to ask them to cover a shortfall in paying wages at the end of the month! Maybe in the past, but not in the future!
Part of this adjustment is going to be tax driven. Corporation tax rates increase from 19% to 25% in March 2023 (for profits over £250k). NIC rates are increasing, tax allowances are frozen (an effective tax increase in real terms). So even if profits remain the same, what is leftover will reduce at the same time that inflation is running a perhaps as high as 10%.
So if you want your business to be ‘sustainable’, i.e. it survives the next 5 + years of turmoil, than drive financial efficiency, control cash ruthlessly, and consider whether you might be better making some personal spending adjustments before them are forced on you.
But let’s try and finish on a more upbeat note!!
In easy times, even poor businesses can do OK. They can scratch a living by being a little bit cheaper than the good businesses in the market. They get in the way of well run businesses. Customers get lazy, don’t shop around to find the best value for money option. When times get tougher, these poor businesses will go and customers will ask more questions around quality and service to decide who they do business with.
What this means is that better businesses often prosper in tough times. If you make your business lean and fit and focus on the right things, you might do even better as your competition struggle.