Emergency bank funding and the CBILS: is it a good idea?
To be clear from the outset: this is not an article about whether the funding support being offered is a good idea.
The question we are addressing here is whether taking on additional borrowing is the right thing for your business.
In the aftermath of the financial crisis, economists talked about ‘zombie businesses’. Those that had been kept alive by government support during the crisis and were able to carry on thanks to very low interest rates, but because they were over-borrowed, could not then generate free cash to recover and thrive when the economy returned to normal. There is a very real risk that a similar situation could arise this time around.
27th March 2020
Mark Neath See profile
The current crisis has created a sudden reduction in demand across the economy. In some sectors, it has eliminated turnover all together.
Staff, creditors and overheads still need to be paid but with reduced income, cash flow quickly becomes a problem.
Unlike a ‘normal’ recession, where the supply of credit becomes tighter, this time banks, supported by the government, appear for now to be maintaining the supply of funds. Indeed, with the benefit of the CBILS guarantee, the supply of credit is potentially increased.
That is not to say that normal banking rules do not apply. Businesses still need to be able to demonstrate that they were viable but for the current crisis; and that they will be able to afford to pay back the borrowing once things return to normal.
Normal advice to borrowers still applies: you need to ask yourself whether or not it is a good idea to borrow?
Or rather, a series of questions that build up to the answer to that.
Firstly, you need to honestly evaluate whether the situation in which we now find ourselves is the sole cause of the cash need:
- Would you be doing fine were it not for this unforeseeable demand-shock?
- Was the business trading profitably and successfully before the current situation?
- Was the funding structure and cash position stable and positive before?
If you can answer all of the above in the affirmative, then consider the second set of questions:
- Can you estimate, making reasonable assumptions, how much you realistically need?
- Assuming your business is able to return to normal, would the cash you were generating in normal times be able repay the borrowing you are now considering?
- Can you assess the sensitivity of making the repayments to the rate of recovery? i.e will it work if only 90% of trade comes back in the first year? Or at 70%? Or 50%?
Ultimately, the question comes down to: can you see your way out of the other side?
Considering some of the above questions in a bit more detail, let us first think about funding structure.
There is a general principle in funding that the funding product ought to match its use. For example, a mortgage to buy a building, an overdraft for working capital, hire purchase for a fixed asset. Of course, in the real world, people don’t create ‘textbook’ businesses. The reality tends to develop on a piecemeal basis over time and to meet specific events. Consequently, the mix of funding products you have in place might not be ideal in the current scenario.
If you have long-term assets funded with short-term facilities, such as overdraft or invoice finance, then converting some of these facilities to a term loan might be appropriate.
If you still have turnover but customer payments have slowed because of their cash flow situation, then an invoice finance product could bring forward these receipts.
Conversely, if you already use invoice finance but turnover has fallen away, your funding source dries up with it. In this circumstance, converting to an overdraft or loan product might be necessary to provide the funds you need.
Therefore, it may not be the case that more borrowing is needed, but rather that a different type of borrowing is more appropriate.
One of the downsides of borrowing is that debt has to be repaid. That is stating the obvious, but it’s a point that tends to get missed by the media when they are talking about the amazing package of support on offer to businesses!
Clearly, if you are able to borrow less in the first place, then the repayment will be less burdensome and the time to recovery shortened.
What can you do to mitigate the amount you need to borrow?
- Cease all non-essential or ‘nice to have’ expenditure as quickly as possible.
- Contact all of your customers, find out if and when they will be able to pay and agree instalment payments if necessary. Any cash in is better than no cash and post-crisis, you will need customers to be there for you.
- Contact your suppliers: can you agree revised payment terms with them?
- If you have term loans or asset finance with monthly repayments, speak with your relationship manager. A capital repayment holiday may be a better solution than more debt.
- Are there new routes to market (e.g. delivery direct to customer) which could be enable stock to be turned to cash more quickly with relatively low set-up costs?
- HMRC has announced a deferral of VAT payments due between now and 30 June, with the payment for this quarter moving to 5 April 2021. If you pay by direct debit and need to take advantage of the deferral, you will need to cancel the direct debit otherwise it will still go out. The VAT return for the relevant quarter does still need to be submitted on time.
- HMRC Time to Pay arrangements are available for other taxes by application through their Coronavirus Helpline on 0800 015 9559, open Monday to Friday, 8am to 8pm and Saturday, 8am to 4pm.
- If a reduction in demand has resulted in some of your workers no longer being fully occupied, one option is to take advantage of the Coronavirus Job Retention Scheme (also being referred to as “Furloughed Workers”). This enables workers to be temporarily laid-off on 80% pay (maximum £2,500 per month), with HMRC reimbursing the business for the cost. The CJRS commences from 1 March so covers the March payroll run but HMRC systems are not yet ready and the reimbursement is not expected to be available until the end of April.
- If your business is eligible to claim Research & Development tax credits or any similar relief, make your claim as soon as possible to generate a tax repayment (if applicable).
If your company year-end is approaching and as a result of the current situation a loss for the year is likely, get the accounts done as quickly as possible to enable loss relief to be claimed and carried back to obtain a refund (if applicable). In any case, preparing the financial statements shortly after the year-end will be helpful in any funding application.
Clearly none of us know what is going to happen with this crisis, so predicting the future is near impossible. However, scenario planning, to see the effect of different assumptions can help inform your decision making.
It has never been more important to maintain the business’ books up-to-date and reconciled to know in real-time where you are.
Looking forward, we recommend maintaining a daily forecast of income and outgoings to keep a very close eye on the bank position. If your business has well-maintained Xero books under an Old Mill subscription, we can connect you to a cash forecasting app called Fluidly. For other businesses, Old Mill can help you to get your books up to (what we call) ‘Cloud Accounting Level 2’, to enable this.
Alternatively, we have developed an Excel spreadsheet tool to help you to manage this manually.
Medium term forecast
For most funding applications, it will be necessary to present a forecast to the bank demonstrating affordability once business returns to normal. Regardless of applying to a bank, it’s advisable to invest time now in modelling a range of scenarios to understand the possible outcomes.
A number of apps are available for this. Fluidly has a twelve month forecasting option at additional cost. Float and Fathom can also be used to build a forecast model, again there are subscription charges applicable.
For those with the time and inclination, Excel remains a powerful tool for financial modelling.
We have developed a template model to provide the basic structure of an integrated profit & loss, balance sheet and cash flow model, onto which we can overlay your specific financials and assumptions.
We find ourselves in a unique situation. There is unprecedented government support on offer, but most of this will not be available as cash until sometime in April. In the short-term, with turnover having suddenly reduced for many, there is a cash flow need.
Emergency borrowing may be a solution, and the government is introducing measures to encourage the supply of credit to facilitate this.
However, jumping straight to borrowing as the solution may simply be digging a deeper hole.
Consider your options, take all of the steps you can to reduce the borrowing need and carefully model future scenarios so that you know your way out.
If you have any questions or would like to know more, please do get in touch.