UK businesses’ cash generation has stayed worryingly low heading into the cash crunch triggered by the COVID-19 pandemic, with mid-sized and smaller businesses faring worst, shows a new study by accountancy and business advisory firm, BDO LLP.
BDO’s analysis of UK businesses shows that they converted just 2.6% of the value of their sales into free cash flow on average last year¹. This figure has stayed stubbornly low after falling from an average of 3.3% just four years ago, prior to the EU referendum.
The largest 100 companies in BDO’s research – all with annual turnovers of more than £3bn – turn sales into free cash at a much healthier average rate of 9.6%. However, performance among mid-sized and smaller companies² has dragged the average down for UK businesses as a whole, as they convert sales to free cash flow at an average rate of just 2.5%.
Mark Lamb, Business Advisory Partner at BDO, says: “The impact of COVID-19 has triggered a cash flow crisis for a huge number of businesses. The fact 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 cash flow, in these conditions, is harder but achievable.”
BDO says that the fall in free cash flow generation in recent years is likely to have been driven, in part, by businesses being forced to compete more heavily on price, quality and service delivery in a slowing economy. These factors have contributed to businesses generating less free cash from their sales.
The firm says that this low level of free cash generation could cause significant problems, as it gives businesses little opportunity to retain cash as a buffer in case of cash flow pressure. This is exactly the pressure now faced by businesses across the UK, as the economic disruption forces many businesses to temporarily close their doors and causes unpaid invoices to stack up.
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 Mark Lamb: “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.”
Law firms generate cash most efficiently – but housebuilders and car dealerships struggle
The sectors that generate free cash most efficiently according to BDO’s study are law firms (19.7% of sales converted to free cash flow).
Says Mark Lamb: “The legal sector has traditionally been resilient and had a strong business model. In recent years firms have made their businesses more efficient and driven down costs as the market has had new entrants and become more competitive. That has served to keep cash flow strong.”
The sectors with the lowest free cash generation rates are housebuilders (0.8%) and car dealerships (1.3%).
London and Edinburgh businesses are the UK’s most cash-generative
BDO’s analysis also shows that businesses in London and Edinburgh are on average the most cash-generative in the UK. London businesses (6.2% of sales converted to free cash) and Edinburgh (5.9%) are both major centres for sectors with strong free cash flow, including financial services and the legal and accountancy professions.
At the other end of the table, regions with the lowest average levels of free cash generation are Lincolnshire (1.2%) and Dorset (1.3%). These primarily rural areas are likely to have seen their rates of cash generation reduced by the size of their agricultural industry, which has seen sharp pressure on margins in recent years.
¹ Accounts filed during the year ending 31 March 2020
² Businesses with a turnover between £20m and £200m
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