East Midlands businesses’ cash generation has stayed worryingly low heading into the cash crunch triggered by the COVID-19 pandemic, shows a new study by accountancy and business advisory firm, BDO LLP.
BDO’s analysis of UK businesses shows that those in the East Midlands converted just 2.6% of the value of their sales into free cash flow on average last year*. The average for businesses in the East Midlands has stayed stubbornly low after falling from an average of 3.3% just four years ago, prior to the EU referendum.
The firm says that many key East Midlands businesses have faced a major cash flow crunch since the start of the pandemic. The effects of lockdown on sales and the rise in unpaid invoices have seen cash flow dry up for businesses, affecting many sectors including the critical East Midlands manufacturing industry.
Suk Aulak, Partner at BDO, says: “The impact of COVID-19 has triggered a cash flow crisis for businesses across the UK, and the East Midlands has been hit hard. We’ve already seen some major businesses in our region forced to lay off staff as a result.
“With the manufacturing industry being such a big part of the local economy, particularly in Derbyshire, it’s vitally important that the Government continues to do everything it can to protect jobs here. With an end to lockdown on the horizon, a return for car sales and international travel would be a boost to our region’s manufacturing sector.
“Our region’s economy has been a real success story over the last few years, with significant regeneration in Nottingham creating a lot of new jobs in industries like professional services and life sciences. That does give us confidence in how quickly we can bounce back.
“That free cash generation was relatively low for so many businesses in the run-up to the outbreak is a worrying sign. To survive this crisis you need good cash flow, improving that, in these conditions, is harder but achievable.”
Free cash flow is a measure of how much cash a business generates, calculated as income less expenses, including tax on profits and after capital expenditure, such as investment in equipment and machinery. In effect, it is the net cash available to pay dividends to shareholders, expand the business and build up a ‘cushion’ of cash in case of economic disruption. A business that converts 5% of the value of its sales to free cash flow is generally seen as very healthy and cash-generative.
Key steps businesses can take to improve free cash generation could include:
- Chase outstanding debts harder – send regular demands for payment rather than statements of account;
- Maintain a programme of regular negotiation of terms with suppliers and have a full costs review once a year;
- Outsource services wherever possible such as finance and IT functions; and
- Maximise the tax reliefs you are entitled to – R&D tax relief is still not properly understood and claimed by a number of UK businesses.
Adds Suk Aulak: “Maximising cash generation has always been vital and is one way to help protect a business in an unexpected downturn. Every business should now be looking at what it can do to grow and maintain its free cash flow. Managing invoicing more efficiently, implementing a cost reduction process, keeping inventory levels under control, restructuring debt and re-banking should all be on the agenda.”
BDO’s analysis also shows that businesses in the West Midlands generate more free cash flow (an average of 2.9% of sales converted to free cash) than those in the East Midlands (an average of 2.6%). BDO says that the professional services hub of Birmingham has helped the West Midlands perform better, with law firms (19.7% of sales converted to free cash) and management consultants (6.9% converted to free cash) being among the most cash-generative sectors of the UK economy.
* Accounts filed during the year ending 31 March 2020