What’s ahead, and how to combat it, for Australian SMEs

After 2 years of unprecedented growth, signs of economic pressure pose risks to Australian business as recessions looms.

Following the Covid-19 pandemic, many Australian businesses have experienced their best years to date. The Covid stimulus packages brought in under the Morrison government, the better-than-expected recovery from the pandemic and record low-interest rates were among the leading factors for recent prosperity in Australian business.

However, a perfect storm awaits, with experts hinting at a recession in the coming 18-24 months.¹ In this case study, we have identified the biggest challenges currently facing SMEs in the hope to help business owners and leaders navigate the uncertain times ahead.

Inflation and Supply

It is not uncommon to hear “the new normal” or “back to normal” in the current context. However, it is worth noting that there was nothing normal about the last 10 years. The 2010s were all about adapting to the Global Financial Crisis (“GFC”) and gave us 12 years of record low-interest rates in a high liquidity environment. The end of the post-pandemic boom, combined with the Russian-Ukrainian war has sparked the biggest global surge in inflation since 1982 with 83% of countries experiencing inflation above 6%.²

The strain on supply chains also continues. In 2021, the Reserve Bank of Australia (RBA) isolated the two phases to the ongoing supply chain disruptions.³

Phase 1: Global lockdowns result in production constraints, and

Phase 2: Transportation issues emerge alongside continuing production constraints.

China’s shift to a zero Covid policy in early 2022 brought a lot of businesses into Phase 1 again, with factory output at its lowest since February 2020.⁴ The lack of stable supply channels has made it difficult for businesses experiencing high demand to meet those targets.

Inflation impacts gross profit, and supply constraints impact production. As the cost of goods increase, gross profit margin decreases. As the supply of parts and materials slows, production can be interrupted, and sales may decrease. Without a clear understanding of the supply risk and the impact critical resources can have on profit, businesses can find themselves in a difficult situation.

Who is at Risk

We have identified three types of businesses that will be impacted the most by increased prices and supply chain bottlenecks.

1. Businesses who do not understand their costs

Typically affected businesses: Manufacturing

Issues

It is not uncommon for us to see businesses facing difficulties despite having record sales. When investigating further, we often realise their prices have barely changed in the last few years because their existing cost models are obsolete.

The most important aspect of understanding your costs is traceability. This goes beyond an excel spreadsheet that sets out the costs of manufacturing one item, for example. Without an effective process to monitor purchasing activity, businesses forgo an opportunity to recover costs and maintain revenue quality.

Having an efficient way of managing inventory is also critical. In the current circumstances, understanding the seasonality and trends in your business is key to minimising impacts on production through careful purchasing. Businesses importing equipment/parts from overseas will be left worse off if they poorly manage their inventory, as shipping costs/delays may be the deciding factor in you turning a profit this financial year.

Solutions

There are several ways a business can understand and control its costs more effectively. At TurnKey Management, we help identify your most volatile costs through detailed financial reporting and analysis. This can help identify cost trends and allow you to recover the increased cost of goods through periodic price adjustments.

For businesses importing supplies from overseas, it is vital to understand the effect of exchange rates on your purchases as this may derail your plans, making goods, and the cost to ship them to Australia, more expensive.

Conducting a sensitivity analysis can be a great tool to see changes to your profitability or production. For example, the impact on profitability if the USD/AUD exchange rate decreases by 5%, forcing you to pay more AUD for the same amount in USD. Similarly, we can look at the impact shipping delays have on production, allowing you to identify critical items and minimum stock quantities and avoid interruptions to production due to a lack of supply.

2. Businesses who do not control their cash flow

Typically affected businesses: Transport, Earthmoving & Mining

Issues

Cashflow management is all about controlling the movements of cash in a business’ bank accounts. Depending on the size of your business, the number of employees you have or the payment terms your customers and suppliers are on, managing cash can be tricky.

Whilst many business owners might look at month-on-month performance to see how their business is faring, the realities of cash flow might mean your business is struggling despite profits on your books. Overstocking, inadequate pricing, or a below-average month in terms of revenue matched with an above-average month for purchases are sure to place a lot of stress on your business’ cash flow.

As part of the Covid recovery, the Federal Government allowed businesses to expense capital purchases fully. This measure drastically reduced the tax bill for businesses and encouraged spending on new assets. The low-interest rates further motivated businesses to buy and meant the upfront benefit of purchasing these assets was high. However, recent measures from the RBA to combat inflation through consecutive interest rate rises has meant businesses are now suffering the hangover from incentivised capital purchases post covid. Repayments are now higher, meaning the business needs to generate more profits to cover its obligations. It is also worth noting that should businesses need to dispose of those new assets in the coming years, they will have to pay more tax.

Finally, poor cost recovery or not having control over clients paying beyond their credit terms will cause major cash flow issues. When a business is already constrained by cash flow, a delay of a few days may be enough to make them breach its overdraft facility or not have enough funds to cover expenses. This can be caused by overreliance on one client or not having the processes in place to effectively recover overdue invoices. In these cases, short-term debtor finance can seem like a good solution, but it will only strain your cash flow further if you are reliant on it every month.

Solutions

Understanding what you pay and when you pay it is essential in uncertain times. This goes back to understanding your costs and making sure your business performs the way you need it to perform. Our reliable cash flow forecasting tool helps you anticipate cash flow problems and implement strategies to combat them. By being able to foresee cash flow problems, you are better positioned to secure short-term finance, request an overdraft facility (or an increase to) or negotiate better terms with your debtors and creditors. This will save you from sleepless nights, knowing your business has a more secure future.

3. Businesses that grow too quickly

Typically affected businesses: Everyone

Issues

Uncontrolled growth ties in directly with the previous point, as it causes a lot of stress on cash flow. Accelerated business growth not supported by sound financial management & strategy during times of boom (rapid economic growth) can often lead to an inability to cover debt obligations (e.g. asset finance) when revenue streams plateau. The diagram below demonstrates the impact on a company’s cash flow when purchasing a new asset. Here the cost of capital to increase production is not met with money coming in until further along the timeline, causing stress on the business.

The above example looks at the purchase of a heavy vehicle for a business trading on 30 days EOM terms, meaning they get paid 30 days after the month in which the invoice was sent. We can see that there have been two monthly repayments on the asset finance before any income is received for the work already done. This may be worsened by a number of other costs associated with the operation of the asset, such as wages of the operator, insurance, fuel, etc.

Whilst the business may afford the repayments and will benefit from an additional asset in the future, there is a short-term negative impact on cash flow due to the financing and operating costs of the asset occurring prior to receiving revenue from operations.

Solutions

Growing too quickly is where poor cash flow management and little understanding of your costs meet. Not understanding these two aspects of your business means you are not able to have a clear growth strategy and risk sacrificing all the work you have done so far. Our holistic approach to business consulting means we want to understand your goals and your business to create the most appropriate growth strategy whilst protecting your assets.

Reach out via the contact form below for an obligation-free meeting to explore your options today.

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