46 percent of Australian firms enter the recovery with negative cash flow
29 March, 2010
The strong economic recovery and positive company reporting season is hiding a deep structural weakness for many Australian firms as new data reveals nearly half of all companies operated with negative cash flow throughout the last financial year. A concern for shareholders and creditors is that the failure rate for firms with negative cash flow is 213 percent higher than for those operating with a positive cash position. These are just two findings from new research conducted by Dun & Bradstreet.
Cash flow tracks the total cash coming in and going out of a firm, usually over a twelve month period, and is regarded as a crucial measure of business health. Many firms with large profits fail as a result of negative cash flow because they fail to manage their costs and collect enough cash in a timely manner to meet ongoing commitments. This situation occurs despite the firm making sales and booking revenue. Dun & Bradstreet data shows that more than 80 percent of business failures are related to cash flow pressures rather than poor sales.
The Dun & Bradstreet research shows that 46 percent of firms operated with negative cash flow in the 2009 financial year; a relative 12 percent rise over the last two years.
Companies operating with negative cash flow in the 03/04 - 08/09 financial year
The data 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 much more likely these firms will fail as credit and other forms of debt have dried up.
In the latest Dun & Bradstreet Business Expectations Survey 28 percent of executives said their ability to access credit had declined during the last quarter. This comes as Dun & Bradstreet's 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, with average business terms rising to 54 days after a brief period of improvement late last year.
According to Christine Christian, Dun & Bradstreet's CEO, 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 meant the cash flow of many firms was 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," said Ms Christian.
"Now, with funding still difficult to come by, 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, this research demonstrates that a firm's profit results don't give you enough information to properly assess risk. If you need to know whether a firm will be around long enough to pay your accounts cash flow is a critical indicator."
In a further sign that negative cash flow is likely to drive a spike in business failures during 2010 Dun & Bradstreet analysis shows that the early years of economic recovery following a slow down actually 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 jumps to 19 percent for firms that have experienced negative cash flow. Critically, the Dun & Bradstreet 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," said Ms Christian.
"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 drastic 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.
Firms with up to 20 employees had more than 50 percent of firms operating with negative cash flow. This figure falls to 42 percent for large enterprises however, this remains a significant figure for firms that are traditionally considered to be stable, well established operations.
Companies operating with negative cash flow in the 2008/09 financial year (by size)
Interestingly, some of the smaller groups are more resilient to negative cash flow than their larger counterparts. Those firms with 1-5 or 5-9 employees have a lower likelihood of failure resulting from negative cash flow than firms of any other size. Those with 10-19 or 20-49 employees have the most significant increase in the likelihood of failure, being 300 percent more likely to fall over than those firms with positive cash.
The electric, gas and sanitary services sector had 52 percent of firms record negative cash flow. Agriculture and mining followed closely behind, with 51 and 50 percent of firms respectively recording negative cash results. Remarkably, the construction sector - which was hit hard during the crisis - accounted for the lowest percentage of firms that recorded negative cash flow at 41 percent.
However, these sectors have traditionally been more resilient to negative cash flow than other industries. The transportation and retail trade sectors are the most likely to fail as a result of financial struggles, with these two groups 800 and 600 percent more likely to fail than their counterparts with solid cash flow.
The research is based on an analysis of company financials on the Dun & Bradstreet database. The database contains financial statements lodged with ASIC as well as financials collected by Dun & Bradstreet from firms that are not required to lodge their company results.
For further information please contact:
Danielle Woods
D&B Corporate Affairs Manager
T: 02 8270 2926
E:woodsd@dnb.com.au
About D&B
D&B is the world's leading provider of business-to-business credit, marketing and purchasing information and receivables management services. D&B manages the world's most valuable commercial database with information on more than 150 million companies.
Information is gathered in 193 countries, in 95 languages or dialects, covering 186 monetary currencies. The database is refreshed more than 1.5 million times daily as part of D&B's commitment to provide accurate, comprehensive information for its more than 150,000 customers.
The Australasian operations were bought out by the senior management group in August 2001. It was the first MBO of a wholly owned subsidiary in D&B's history worldwide.
Today Lazard Carnegie Wylie owns an approximate 90% stake in DBA and the local management team a 10% stake.
Strategies for future growth include developing DBA's commercial and consumer credit referencing business; expanding its receivables management outsourcing business; maintaining its lead in the development of unique credit and risk scoring products; and developing new products specifically tailored to the Australasian market. DBA currently employs over 500 people in Australia and New Zealand.
