Structuring Funding And Reducing Costs

Daniel Cloete from Westpac looks at issues that may influence your cost base and how to make sure assets are funded appropriately

The recent jump in inflation in the US, and shortages resulting from interruptions in the normal supply chains, have made many business owners worried about the possibility of increased costs. Together with the way that Covid-19 has exposed risks in the business environment, this has made people a lot more aware of how important it is to watch their overheads and other costs. That’s always a worthwhile exercise – and as part of it, it’s important to make sure that your business assets are funded using the right products and over the appropriate time frame.

Despite expected growth, economic conditions are likely to remain uneven across sectors for some time to come in New Zealand and beyond. Across the globe, it has also become evident that Governments are using the pandemic as an opportunity to change policies. So how can you structure your business funding to minimise risks from these changes?

Funding structures

In recent years, historically-low interest rates have meant that it has been a lot easier to afford funding for business ventures. The focus moved from interest rates to capital repayments, which are particularly influenced by the term (time) over which the funding is done. In addition, rapidly escalating house prices in New Zealand created lots of equity that could be used to secure lending to SME businesses. That meant funding could be structured at secured rates over a much longer time, thereby easing the pressure and reducing costs on cashflow.

However, funding business assets like fit-out, equipment or vehicles over a longer period than their useful economic life presents its own set of that may influence your cost base and how to risks. For instance, if you are required by a mall or a franchisor to refurbish your store every five years, but your funding is secured over a much longer period against your home, you could easily be saddled with a lot of business debt in your personal name instead of the business funding itself.

This is something that you should carefully consider when initially funding the business or when buying assets. It would also be a good idea to discuss the implications with your accountant and business banker. Using the right mix of secured and business funding, and using the appropriate equipment finance, can go a long way to saving the business money whilst balancing the risk to the owner.

Reducing the cost base

After a year of Covid-related interruptions, we heard a lot of anecdotal evidence that franchise systems dealing with supply, rent and other issues, were having to adjust their whole profitability model. In an extreme example in one industry, 64 percent of the employees left the industry with no guarantee that they will come back after the borders re-open. Other companies found that the transport cost of importing supplies doubled or even tripled in some cases, on top of supply chain issues. This is bound to have a negative effect on their cost base, and on the prices of their end product. In this environment, the franchisor or franchisee purchasing group needs to step up efforts to ensure the model stays viable and profitable.

This is one of the areas where a franchise business model can truly prove its worth. One of the most important benefits of franchising is being able to use the collective buying power of franchisees to match the large corporates. In fact, many of New Zealand’s best-known franchise brands started out as buying groups for exactly this reason, with companies like Mitre 10 and Foodstuffs continuing to operate this way.

In addition to giving more attention to using the group’s purchasing power to drive down the cost of their stock and improve terms, franchise systems can also help franchisees improve profitability by looking at IT systems, transactional and merchant costs, HR, marketing and compliance costs. Increased digitisation, online support, reduced travel and people working from home can all help reduce overheads.

Managing cashflow

Managing cashflow seems to be one of the biggest challenges for small business owners. Contributing factors include the timing around tax payments; staffing; holiday payments; seasonality in sales; or unexpected repair or other bills. Some business models, such as project management or equipment rental, may take a long time to get to a breakeven point and can suck up more capital as they grow. Having a funder that really understands your particular franchise model is important. Here are some examples where having good cashflow management, and an informed funder, are important.

• If your business is of a type that doesn’t tend to be cashflow positive from day one, the shortfall will need to be funded via working capital until you reach breakeven. New businesses tend to overstaff in the beginning for various good reasons, and costs could be abnormally high. An experienced accountant should be able to help identify your cashflow requirements and a banker that understands the business model can then fund working capital shortfalls.

• Don’t make capital expenditure using cashflow, unless you can really afford it and understand the implication on future cashflow. Just because there is money in the bank, it does not mean you can spend it on equipment or upgrades, or you may find that there is suddenly no money to pay the wages at the end of the next month. Make sure capital expenditure is made using the right funding product and term.

• The same applies to businesses that experience strong seasonal sales. A retailer in the giftware or stationery industries may need additional working capital in September to buy in stock for the Christmas season.

• Re-opening or launching after Covid-19 or other interruptions may require additional funding rather than using the non-existent cashflow from a period of closure.

• If you suddenly need a temporary overdraft for the business, your banker is going to want to know the reason (eg. emergency repairs on equipment) and the source of clearance (eg. future profits proven by your management accounts). They will definitely not be keen to fund you because your debtors are not paying because you don’t have good credit control procedures in place, or because you are making trading losses (unless there are very good reasons).

Managing your cashflow properly requires having a good management information system in place. With accounting packages like MYOB or Xero, and some really good add-on reporting software, this has become more readily available. In addition, many franchise systems offer extensive stockcontrol, marketing, invoicing, online training and other features, allowing franchisees to better manage their business.

Understanding trends in basic KPI’s including Gross Profit margin, wages and other costs in a timely manner, allows the business owner to take active steps to improve profitability. This also allows the business to provide up-to-date financial information to the bank, which can then in turn fund the business and any working capital or plant and equipment requirements on the strength of the financial reporting. It’s worth noting that good quality financial information will also support a much higher price when selling your business.

Nothing is certain in business, and a certain amount of risk is inevitable. However, by making use of good systems and working closely with a qualified accountant, the modern franchisee can make sure that they use optimal funding solutions, manage the business and its cashflow effectively, and have an altogether better and smoother ride.

About the Author

Daniel Cloete is the National Franchising Manager for Westpac. For more information, contact your local Westpac Franchise and Business Banking Specialist on 0800 177 007 or email: franchising@westpac.co.nz The information contained in this article is intended as a guide only and is not intended as an exhaustive list of matters to be considered. Persons entering into franchise agreements should seek their own professional legal, accounting and other advice.