The strong economic recovery and positive company reporting season is hiding a deep structural weakness for many Australian firms. New data reveals nearly half of all companies operated with negative cash flow throughout the last financial year and alarmingly, the failure rate for firms with negative cash flow is 213 percent higher than for those operating with a positive cash position.
Cash flow tracks the total cash coming in and going out of a firm and is regarded as a crucial measure of business health as data shows that more than 80 percent of business failures are related to cash flow pressures rather than poor sales. Many firms with large profits fail to manage their costs and collect enough cash in a timely manner to meet ongoing commitments - these firms often end up failing as a result of negative cash flow. This situation occurs despite the firm making sales and booking revenue.
The research shows that 46 percent of firms operated with negative cash flow in the 2009 financial year; a relative 12 percent increase over the last two years. The data also reveals that a relatively large number of firms have operated with negative cash flow for a number of years. However, the real concern is that while this practice was sustainable during the boom years, largely due to easy access to credit facilities such as bank overdrafts and debt funding, the current environment makes it significantly more likely these firms will fail as credit and other forms of debt have dried up.
Evidence of this trend can be found in Dun & Bradstreet's Business Expectations Survey where 28 percent of executives said their ability to access credit had declined during the last quarter. In addition, the latest trade payments data, which tracks the speed with which businesses pay their suppliers, shows that creditors are experiencing cash flow pressure from slow customer payments. Average business payment terms have risen to 54 days after a brief period of improvement late last year.
The research demonstrates that although the credit crisis appears to be behind us, it has left a substantial portion of Australian firms in a position that could be difficult to recover from. The persistent culture of late payment in Australia caused the cash flow of many firms to be challenged even before the credit crisis hit and as a consequence, some executives were not well positioned to deal with the crunch when it came.
Now, even as Australia embarks on its journey back to normalcy, funding is still difficult to come by. Therefore, corporate Australia is facing a situation where cash flow troubles - which have traditionally only been a concern for SMEs - have become a priority for some of the largest firms in the country. For those firms that extend credit to their customers, whether it is bank or trade credit, the research demonstrates that cash flow is a critical indicator for determining whether a firm will be around long enough to pay its accounts.
In a further sign that negative cash flow is likely to drive a spike in business failures during 2010, analysis shows that the early years of economic recovery following a slow down bring a rise in business failures rather than an improvement.
In the 2001 financial year as the economy returned to positive growth following the 7.1 percent contraction in the March 2000 quarter, business failures jumped 20.5 percent. This was followed by a further increase in failures of 5.1 percent in the 2002 financial year when Australia recorded GDP growth of 3.8 percent. Failures did not begin to decline until the third year of recovery. The cause of this spike in failure rates is a rise in business costs - particularly labour and raw materials - which is driven by increasing orders. However, because there is a significant gap before payment is received the negative cash flow drives the spike in business failures.
In total Dun & Bradstreet rates around 10 percent of firms as a very high risk of experiencing financial distress over the next 12 months. However, this figure jumps to 19 percent for firms that have experienced negative cash flow. Critically, the data shows that firms that have experienced negative cash flow remain a higher risk of eventual failure regardless of whether they experience a period of positive cash flow in the future.
This research has significant implications for corporate Australia and the nation's economic recovery. Despite a solid profit reporting season which raised confidence levels within the business community, this research shows that a substantial portion of firms are actually facing relatively serious financial struggles. With borrowing to cover shortfalls largely out of the question as financial institutions retain the risk averse stance they established during the height of the crisis, Australia could experience a significant spike in companies entering external administration this year and into 2011.
The research also exposes the demographics that have been most affected by the credit crisis and those that have traditionally been more resilient to negative cash flow. Smaller firms and those in the agriculture, mining and gas sectors recorded the most significant percentages of firms operating with negative cash flow in the 2008/09 financial year.
To request a copy of the full report email: marketingdept@dnb.com.au
