All on Board: Strengthening the foundations in 2012

Charles Beelaerts gets advice on how SME directors can tackle growth and debt-management trends in 2012.

Experts agree that in Australia a number of sectors are in a recession, but that there are steps directors can take now to capitalise on the upturn when it comes. However, it is essential to focus on managing the downside during volatile times before concentrating on managing the upside.

Growth trends

Paul Billingham, national head of recovery and reorganisation at Grant Thornton Australia, sees very little happening for small to medium-sized enterprises (SMEs) over the next 12 months.

"The best you can hope for is steady as she goes and not a great amount of corporate activity, but the banks are being very supportive and they are keen to see growth, and seeing businesses fail will not achieve this."

Don Ross, professor of finance at the Australian Catholic University, is similarly cautious about growth.

"We are still pretty much in the aftermath of the global financial crisis (GFC). There is a lot of volatility and you have to be really cautious about your growth plans, especially in the context of debt."

Ross expects directors to take a more conservative view of growth and focus on their balance sheets and trying to rebuild.

Don Rankin, chairman, Pitcher Partners National Association, says a company’s growth prospects are going to depend on what sector it is in. "If you are in mining or mining services, growth prospects are really strong but, on the other hand, if you look at manufacturing, it is under pressure and has been in Australia for a number of years. Now with where the dollar is, that pressure has gone through the roof."

David McEvoy, senior partner in PPB Advisory’s corporate restructuring practice, also expects limited growth opportunities in 2012. "It is more a case of getting the basics in order and ensuring the organisation is there to position itself for the long term when the overall consumer sentiment changes. However, directors should first manage the downside risk and then position businesses for the upside down the track."

Corporate and funding restructuring trends

McEvoy sees opportunities in mergers and acquisitions that are largely driven by the fact that many businesses will not achieve adequate returns and therefore will build scale to achieve the returns the market is looking for.

However, he adds: "This is counter-balanced to some extent by risk aversion and by lack of capital, which may mean there is a supply of businesses on the market for sale but there isn’t necessarily the demand or appetite to purchase them."

Ross says directors need to be conservative when looking at capital structuring in 2012, noting that traditionally retained earnings top the pecking order when financing is examined.

"If a company finds itself being squeezed in 2012, it should not try to borrow a lot of money. The company should keep the focus on balance sheet weakness and try to build up its equity stream primarily through retained earnings."

Funding at present is difficult to come by and it is generally agreed that this will continue into 2012. According to Billingham, SMEs are primarily focused on survival and not a lot of new lending is being sought. "The banks are all looking for blue chip lending and this comes down to the quality of the company they are lending to and the lending criteria is tight."

Billingham adds that there are a lot of lazy assets on the balance sheets of SMEs and cites property and inventory as two areas where this is especially the case. "There are ways of improving the profile of a company’s debt structure without borrowing any more primary debt from a bank," he says.

Ross sees the banks’ diminished appetite for risk as a primary challenge for directors in 2012. "The banks are going to lower loan-to-valuation ratios and require more equity positioning and they themselves may start to worry a little so they will play it safer. Day-to-day cash flow management will become more crucial and companies will have to wait longer to get paid."

It is generally agreed that funding will be more difficult to get and more expensive in 2012. "Australian banks are heavily reliant on offshore wholesale funding and the cost of this may continue to increase. A combination of such things as capital adequacy rules and global forces points towards wholesale funding being more difficult or expensive to access," says McEvoy.

"Businesses are going to have to come back to accepting that conditions that existed a couple of years before the GFC probably are not going to return and raising funds is not going to be easy, although it will get better," adds Rankin.

Advice for directors in 2012

In 2012, directors need to ensure management’s operational plan is robust. "Where the operational plan is put up by management, directors should not just accept it and they should really question it and conduct sensitivity analysis," says Rankin, noting that SME directors have not traditionally been good at doing this.

In particular, directors should ask management for detailed cash flow forecasts. Most companies do an annual budget, but McEvoy says he is "continually surprised at the lack of sophistication with cash flow forecasts and working capital management". Management’s cash flow statements, he says, should contain actual versus forecast figures and an explanation of variances.

Billingham’s advice for 2012 is to know what works and what does not. "Invest on the margin and do not try to grow yourself out of difficulties. Also be upfront with your lender as banks are only supportive if you have a viable plan."

Importantly, he says now is not the right time to dabble in something you do not understand. "Don’t get bored or distracted and think that doing something else under the guise of diversification is the right thing to do."

Ross expects the first six months of 2012 to be like the last six months of 2011. The best thing for directors to do, he says, is to build strong balance sheets. Only if companies have a very targeted opportunity should they expand and gear up and generally they should move ahead with caution. "The current climate comes back to the optionality of capital slack. You should have some slack in your capital structure and some cash resources you can take advantage of in 2012," he says.