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Finding a more flexible finance model

06 February 2017

Building the right business model and having the budget to achieve sustainable profitability starts with a recognition of the financial issues facing your company now, and in the future, says Roy Royer. 

Banks today are under increasing pressure to meet capital adequacy and other balance sheet requirements – making it harder to deploy capital. Unfortunately, as capital slows, food industry growth plans often follow. This has led to an increased use of Private Equity to fund projects and this can appear attractive for some situations, but can prove costly, in terms of dilution if the current shareholders later see significant enterprise value creation. So, in many ways, it is like using a sledge hammer to crack a nut.

There will always be a level of uncertainty. Technology bubbles, real estate bubbles, macroeconomic sluggishness, regulation – there is always an excuse to live with mediocrity. A simple diversification approach of letting real estate lenders do real estate, equipment-driven lenders handle equipment with banks handling the working capital, could create greater opportunity. By forcing too much of your lending into the bank, you may be limiting the growth potential of your company. Diversification can lead to greater access to more flexible capital when you need it most.

Food executives rely on contract manufacturers being nimble and adaptable to meet changing consumer food fads. However, with British food companies lagging behind the technology efficiencies offered by automation, combined with the trend for very short-term production contracts, food companies are often anything but adaptable. With contract terms as short as 18 months and dated processing technologies, it is a challenge to equip lines for flexible production without enormous capital outlay and significant end of contract risk. These capital risks and budget concerns often limit growth plans or the ability to competitively bid for new business.

To solve this, food manufacturers and distributors need to look at out-of-the-box alternatives to limit end of contract risk and high uses of cash to equip for a new agreement. Flexible rental agreements can offer companies the ability to obtain the equipment they need, preserve cash and leverage the unmatched flexibility to return in the equipment should the contract end, or renew the rental agreement if the production contract renews. With le monthly payments, budgeting also becomes more predictable and the ability to afford new technology increases.

Matching revenues and expenses
With the short term and often transient almost transient nature, of food production and distribution agreements it can be difficult to match cash outflows with inflows. It can take a minimum of six months to achieve the cash flow benefits of a production agreement between recovering the initial investment and pushing through the pains of the receivable cycle to achieve ROI. This gap can create a cash drain that impacts the overall operations of the company.

A rental or structured lease payment, where contract risk is shared, allows financial managers to more easily match income and expenses. With 100% or nearly 100% financing from an equipment-driven finance partner, companies are able to limit the up front cash impact of a new agreement. Simple monthly payments allow for ‘ramping up’ of expenses into a new contract affordably, while allowing more time to generate the revenues to show profitability sooner. And finally, the end of contract flexibility to turn in the equipment in the event that the contract is terminated, or simply renewed if the contract continues beyond the original short-term agreement. This solution offers the ability bring in new business affordably, with the ability to quickly scale food operation to meet fast changing customer demands.

Roy Royer is head of business development at Somerset Capital.

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