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Avoiding a funding deficit

Avoiding a funding deficit

Cash flow forecasting can help business identify the a step in funding needs, protecting against possible missed growth opportunities.

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It is often said that cash flow is the lifeblood of a business. However, an ongoing assessment of funding needs is not always a high priority in day to day business planning.

Business plans often focus on core issues like revenue growth, product pipelines, customer relationships, and the associated cost and margin impacts. While consideration may be given to the funding of significant capital projects, day to day cash flow and medium term working capital requirements are sometimes overlooked.

Delivering consistent growth requires timely investment to drive a business to the next stage of expansion whether that is through new product development, entering new markets or increasing headcount and capacity. The intention of cash flow forecasting is to identify a step change in funding requirements so as to avoid missed growth opportunities or eroded market share while the business waits to raise finance.

Working capital investment

Businesses will generally be aware of the extent to which they can draw down current sources of external funding such as shareholders’ funds or existing debt facilities. However it is the challenges involved in converting the profits to cash that most often results in funding deficits. 

For many businesses, profits do not necessarily convert to operating or free cash flow in the period in which they are earned. The need to invest in working capital to generate incremental profits can result in poor or volatile EBITDA to operating cash flow conversion ratios which can threaten a business’s growth prospects or indeed survival. 

SMEs with limited funding headroom are particularly vulnerable to a cash flow shock. The natural instinct is to accept exciting new opportunities as they present themselves focusing on the delivery at a later stage. This works fine so long as the financial and operational capacity exists within the business. However, unplanned new business opportunities can stress cash flow resulting in business failures even as we leave the recession behind and experience strong economic growth and consumer demand.

For working capital intensive businesses such as those in the manufacturing or consumer goods sectors, ramping up production or expanding into new export markets requires investment in increased stock levels or the extension of generous terms of trade to significant new customers. Services focused businesses can experience similar pressures in having to increase headcount in line with incremental business growth. 

Cash flow forecasting

Improved visibility of each cash generating business segment can also result in a relatively quick improvement in cash conversion. This is particularly the case where cash flow metrics are monitored and/or incentivised.

Preparing 12-18 month rolling cash flow forecasts should provide sufficient visibility of any potential funding gaps. Realistic assumptions which take account of seasonal and one-off events are important.  Equally important is stressing assumptions to estimate the funding needs in a worst case scenario.

 Capital projects and M&A activity are a key component of any strategy to increase a business’s capacity, footprint and operational efficiency. Given the significant cash outflows involved, these projects require a robust appraisal process to ensure they are appropriately costed and funded in their own right. 

Positioning for growth

A growing business will almost certainly require an injection of capital in order to expand.  The challenge is to forecast the requirement in good time. This will ensure your business is well positioned to capitalise on exciting opportunities as they arise, and will help convince prospective investors and lenders to come on board.

If you require further information, please contact Gavin Sheehan or any member of our KPMG Private Enterprise team.

This article was originally published in the Sunday Business Post 25/09/2017 and has been reproduced here with their kind permission.

© 2018 KPMG, an Ireland partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

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