NatWest Business Builder: Cost structure
The average annual expenditure for SMEs is £1m, with the biggest costs being new staff, paying suppliers and investing in technology. Savvy cash flow management is vital to managing these costs.
Spending decisions can make or break an SME. As Emma Chesson, head of online services at chartered accountancy and business advisory service Kreston Reeves, puts it: “There’s a balancing act in managing expenditure and business expense that’s a little like running a race car, swapping cash for fuel: if you under-fuel the car and drive recklessly, you’ll quickly run out; if you over-fuel and drive too cautiously, you’ll be overtaken. Businesses that are reckless with their spending will fail, but if you are too risk averse your business is unlikely to succeed.”
Chesson summarises the biggest spending decisions SMEs and fast-growing businesses face as the ‘three Ps’: people, premises and promotion.
“For some businesses there will also be significant capital investment in plant and machine to enable them to carry out their business,” she adds. “Not only are these likely to be significant, they’ll often have to be borne upfront.”
Savvy spending
When Ed Challinor and Dr MJ Rowland-Warmann co-founded private dentist Smileworks Liverpool in 2013, they were turned down for funding, which placed severe limitations on their planned expenditure.
“In hindsight this gave us an opportunity to run a tiny practice with none of the overheads of a large dental practice and learn the art of business finance along the way,” says Challinor.
Eventually, they were able to lease the state-of-the-art dental equipment that enabled them to offer dentistry on a higher margin, while still keeping the costs down to a minimum. Smileworks Liverpool is now growing fast, with a net profit margin of between 30% and 70%.
“All of this profit is reinvested because we’re still growing,” says Challinor. “Our initial investments were all calculated to improve revenue or cut costs.”
For London real estate broker Stonelink International, the wider economic environment prompted a halt on spending in 2017.
“For a long period there it was a matter of patience,” says director Nicholas Tsiougos. “It was a very difficult period, followed by uncertainty in our industry with clients simply pausing from making any investment decision.
“We couldn’t hire new talent, nor could we make the immediate changes required. So we went into a highly resourceful mode with little to no spend at all, with key objectives every quarter, and we stuck to them. Slowly, over the course of 12 months, the clients we wanted started to knock on our door.”
Question your motives
Even if the time is right and the funds are available, you should still take a critical view of your proposed spend.
Simon Paterson, partner at Surrey accountancy firm RJP, recommends considering whether you’ll get value from your proposed spend.
“It’s all very well spending on, say, marketing and advertising, but if all of your work comes from referrals and word-of-mouth, it’s a potentially pointless spend.”
The question of whether to spend on new staff is often the most difficult one for SMEs.
“You’ll be able to see if you’re heading for a cash-flow squeeze further down the road and be able to take preventative action”
Bev Hurley, chief executive, YTKO Group
“Unless you have a healthy and pretty certain sales pipeline, and a bit of working capital in the bank, taking on a new overhead can be daunting,” says Bev Hurley, chief executive of enterprise creation and business growth specialists YTKO Group and chair of the Institute of Economic Development.
With this in mind, it’s worth exploring whether you can simply enhance the efficiency of your existing team, says Paterson.
“As a company grows, you often see them take on more employees when really if you looked at the systems in place within the company, it could be that processes could be improved, which means you don’t have to take on more staff – which ultimately leads to increased profits,” he adds.
Managing cash flow
For Challinor, adequate cash-flow management must underpin any spending decisions. “At the end of the day it’s running out of cash that kills businesses – at an alarming rate,” he says. “There are five ways to improve cash flow: cut costs; make more revenue [by increasing prices if you can]; extend payment terms with suppliers; reduce customer payment terms; and reduce inventory. A sixth could be: lease – don’t buy.”
Business growth expert Royston Guest, CEO of business consultancy Pti Worldwide and author of Built To Grow, adds that you should keep on top of your company’s creditor days (how many days pass before it pays its creditors) and its debtor days (how many days it allows to pass before its debtors pay).
“Understanding average creditor/debtor days is the foundation of a well-run business and cash-flow management,” he says. “But having an understanding is just the start: SMEs need to dedicate time and resource to establishing and maintaining a system for the collection of monies in, for chasing down overdue debtors and for optimising payment terms.”
Hurley recommends creating a cash-flow forecast and updating it at least weekly. “You’ll be able to see at a glance if you’re heading for a cash-flow squeeze further down the road and be able to take preventative action,” she says.
She also suggests running credit checks on potential clients to weed out bad payers, make it easy for customers to pay you (for example, by facilitating online payments) and build good relationships with internal accounts teams for your suppliers and your clients.
“Try to ensure you have a diverse client base rather than putting all your eggs in one basket, and heed your early warning signs and take action – don’t put your head in the sand,” she adds.
Spending wisely: five things to get right
1. Decide whether there is a real benefit to the spend. “Often you see SMEs making needless purchases that don’t add value to a business and are more of a lifestyle spend,” warns Paterson.
2. Consider spreading the cost of any major investment over the lifetime of the asset. “This is particularly useful for expensive plant and machinery,” says Chesson.
3. Have real-time financial information to hand. “Your profit and loss, cash-flow forecast and balance sheet are essential financial tools that will allow you to see the big picture and proactively determine what’s possible,” says Guest.
4. Take a step back and look at the financials of your business and ask yourself: would I invest with my money? “If the answer is yes and you’ve removed all your confirmation biases and downgraded your estimates by a safe 20%, go for it,” says Challinor.
5. Make sure you’re fully aware of all the costs. “For example, recruiting a new team member might include recruitment costs, and then there are the tools for them to be effective – their computer, mobile phone and so on,” says Guest. “There’s not only their base salary to consider but all the additional costs of national insurance, pension and expenses.”
Further Reading
- Smart savings for start-ups
- SME Tools: eight ways to rein in business costs
- Managing cash flow: procurement
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