Profit matters. Don’t forsake your Queen.

The ‘wise old men’ of business never cease to remind us that cash is King. They repeat, time after time, that viable companies often fail because of cash shortfall. This is of course true and nobody in their right mind would argue that sufficient cash isn’t critical, especially in uncertain economic times.

But cash flow is not an end in itself, it’s a means to an end, a window to generate Profit, the ultimateraison d’être’ of any business. Profit should always be your Queen.

A recent trend in SME finance, particularly amongst fintech platforms, is the provision of overdraft style, short-term revolving credit facilities that charge very high interest (often over 25%APR) and typically come with considerable arrangement fees. For the occasional cash squeeze these costly products can be justified but lenders are happily allowing these products to be used many times over and to be used for the wrong reasons. Furthermore, these products sometimes fail to be marketed in a manner that is fair, clear and not misleading as per FCA guidelines.

At EquipmentConnect we are witnessing examples of companies assuming too much short term debt under the guise of improving cash flow every day. Here are some examples:

1. An asset finance request was recently submitted on the platform from a small company that was paying more than half of it’s gross profit on interest and finance costs. The gross profit margin was already tight at 15% but it was contracting on the back of higher raw material costs linked to the devaluation of Sterling. It turned out that for most of the previous year, the company was effectively financing two large customers by way of a large and expensive overdraft facility, a credit card and two platform based, credit facilities. In total the amount of short-term credit being relied on represented almost half the annual turnover! Our affordability model identified the risk and declined the request.

2. In the SME asset finance sector where EquipmentConnect operates, customers are often quoted a periodic rental payment with minimal or no information being offered on how those payments would compare to the cost of owning the asset over its full lifetime. We recently spoke with a customer who failed to realise she paid more than the full price of equipment within 24 months under a rental lease contract.

3. Another example of where SMEs are sometimes blind sided by ‘cash flow optimisation’, is the financing of annual bills monthly with an APR that is often over 30%! An Equipment Vendor recently told us they were hit with 68% APR so they could pay annual employee liability insurance in monthly instalments. Thankfully they declined. If the cost of cash flow to your business is that high then you should carefully consider if your business is worthwhile or is in fact, sustainable! **

As a director of a small or medium sized business you are a very busy person. You are most likely commercially minded but let’s face it, you probably have better things to do than drill down the profit implications on a hire purchase contract.

Hence, as market participants we have an obligation to make sure that the full picture is accurately and objectively portrayed to you as a potential customer so you can focus on what’s important – expanding your business.

Let’s collectively keep the focus on profit without forgetting cash flow. No entrepreneur wishes for an audience with an unhappy Queen.

** Most companies ought to be aiming for a return on equity / ROE (after tax) of at least 25%. In micro SMEs where owner managers may be compensated in part by salary this hurdle may be lower but on an ‘all-distribution’ basis that is approximately the hurdle. If you are curious to look more at typical return on equity across the economy you can see some stats, kindly published by Stern NYU business school here.

Pin It on Pinterest