The cost of poor cash management

With the growing number of business failures, such as the recent events surrounding Elonex Plc, how does one answer the question of why some businesses survive and others fail? What is it that really differentiates one from another?

Crystal ball gazing is certainly not going to provide the answer, but when it comes to the crunch, the management of business and its money remains a crucial factor.

Elonex UK Ltd, which holds a small stake in Elonex Plc is of course currently unaffected, as is the parent registered in the British Virgin Islands, Elonex Holdings Ltd.

So, how come a business running for about 20 years with £7.5m in cash at the end of 2005 can come off the rails so quickly? Was there ever an indicator that all was not well and that administration was a likely outcome?

While working capital still appeared healthy at more than £5.7m in 2005, some clues were evident in other areas of the balance sheet and the market in which it plied its trade.

The company’s web site boasted that being an independent business not subject to the instability created by being a listed public company gave it a massive advantage, allowing it to plough profit back into the business and ultimately to its client base in increased services and products.

Sales had declined progressively since peaking at more than £100m in the late 1990s to a low of about £39m in 2005. Surprisingly, gross margin declined by only two per cent between 2002 and 2005, a result perhaps of moves into new product areas to combat the serious threat of A-brands (in which Dell led the charge) into its traditional marketplace and line cards.

However, profitability had declined rapidly from a pre-tax profit of just over £1m in 2002 to little more than £87,000 in 2005. Taxation in that year took it to a loss of £271,000. Neither of these figures were really enough to knock a hole in net asset value that remained positive at just over £3m.

Declining sales and profitability were not something the firm could control materially. While they may have been more successful in managing its trade debtor book in recent years, the two areas that suggested a problem centred on direct costs that remained largely static despite this substantial decline and a rising inventory value.

Eventually the company borrowed a substantial amount of money, des-pite healthy cash balances. It financed receivables and carried short-term borrowing of £2.8m in 2005, with additional long-term loans of £5.9m.

Given a further decline in sales and profitability, the company ran out of money, despite the apparent cash pile last year. After all, it was only just enough to pay back borrowings.

Management of cash or working capital is generally a primary cause of business failure, even more so in the cases of long-established businesses. How one manages the crucial elements of debtors, creditors and inventory determines whether you fail or survive and thrive. This is not just a requirement in periods of decline, but more so in periods of growth.

Managing your debtors and inventory determines how you pay your suppliers and provides the business with the stability required to assess and react to declining profit. Fail in this crucial exercise and your business survival is seriously at risk.

This is not just a fundamental rule of business survival for large or long-established companies. It is the essential life-blood of any business.