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May 31 2012

A blueprint forBritish businessPart one: cash management and liquidity

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OVERVIEWBritish companies are hoarding cash as theywait and see what happens in the economyCOST-CUTTINGMaking savings can generate revenue andeven fund growthCASH FLOWIn an era of austerity, a strong balancesheet is vitalSMALLER COMPANIESEntrepreneurial businesses needbanking supportCURRENCIESFinancial instruments can be used as ahedge against a strong poundMANUFACTURINGCompanies can no longer rely on banklending – but are coping surprisingly wellOPINIONJonathan Guthrie on UK plc’s doomedgolden age

CONTRIBUTORSBRIAN GROOM is the FT’s business andemployment editorJONATHAN GUTHRIE is the FT’s CityeditorMICHAEL HUNTER is an FT marketsreporterMICHAEL KAVANAGH is an FT companiesreporterJONATHAN MOULES is the FT’s enterprisecorrespondentPAUL SOLMAN is a freelance journalistJESSICA TWENTYMAN is a freelancejournalist

ILLUSTRATIONSNick Lowndes

Special reports editor Michael SkapinkerEditor Hugo GreenhalghCommissioning editor Robert OrrProduction editor Jearelle WolhuterSub-editor Camilla ImperialiPicture editor Michael CrabtreeArt director Derek WestwoodCommercial director, Emea Dominic GoodHead of solutions Patrick CollinsHead of project delivery Rachel HarrisIntegrated solutions manager Alexis JarmanAdvertising Peter Cammidge

All editorial content in this special report is producedby the FT. Our advertisers have no influence over, orprior sight of, the articles or online material.

BLUEPRINT FOR BRITISH BUSINESS | OVERVIEW BLUEPRINT FOR BRITISH BUSINESS | CASE STUDY

Several large FTSE companies, including Glaxo-SmithKline and AstraZeneca, the pharmaceuticalgroups, and BP, the energy company, have deniedthey are sitting unnecessarily on cash piles.

BP says it is investing more in the UK nowthan in recent years, with £4bn committed tovarious offshore projects over the next five years.

Carmakers have pledged substantial invest-ment, helped by demand in emerging marketsand a flexible workforce. General Motors’ £125minvestment in its new Astra at Ellesmere Port onMerseyside comes on top of £4bn of commitmentsfrom Jaguar Land Rover, Ford, BMW, Bentleyand Toyota.

InterContinental Hotels, Subway, McDonald’s,Starbucks and Marston’s are among leisurechains planning expansions that will create thou-sands of jobs. National Grid aims to spend £31bnby 2021 upgrading Britain’s gasand electricity networks.

Companies that investwhen others do not canprime themselves forfuture expansion andsteal market

UK companies are sitting on £754bn in currency and deposits, as they hold back on investment decisions, writes Brian Groom

Access denied

POLITICIANS ANDeconomists have been pressingcompanies to start spendingtheir cash piles, so an upturnin business investmentreported in provisional data forthe first quarter has come as awelcome relief for those who

manage companies’ capital.According to the UK’s Office for National

Statistics, business investment – which had fallensharply during the 2008-09 recession – rose by 3.6per cent in the three months to March comparedwith the previous quarter, and by 14.2 per centcompared with a year ago.

It remains, however, more than 9 per centbelow where it was in early 2008. With the UKeconomy in a double-dip recession and freshinstability in the eurozone, companies are boundto remain nervous about investment.

Businesses have been rebuilding their balancesheets, which, in many cases, were over-gearedbefore the financial crisis. UK companies,excluding banks and financial institutions, haveamassed £754bn in currency and deposits, equiva-lent to 50 per cent of gross domestic product,according to official figures. Not all of that maybe available for investment in Britain – the big-gest growth is in deposits held with foreignbanks – but few doubt balance sheets arestrong. Yet many companies have beenunsure about when to start spendingamid uncertain prospects.

“Business will always pause oninvestment if it thinks it is notgoing to get a return because themoment is wrong, because thereisn’t enough consumer andcustomer demand,” says JohnCridland, director-general of theCBI, the employers’ group.

Peter Spencer, chief eco-nomic adviser to the Ernst& Young Item Club, the non-governmental forecastinggroup, says the UK will notbegin to prosper until thesefunds are put back intothe economy. “Until thesecompanies stop stashingthe cash and startincreasing levels ofinvestment and divi-dends, the economywill remain on thecritical list,” he warnedlast month.

Philip Booth, editorial director at the Instituteof Economic Affairs, says: “If I were a share-holder I would be asking directors why theywere sitting on cash that they could return toshareholders – why are we not paying dividends?It’s not a company’s job to sit on piles of cash.”

He agrees, however, that it is rational for com-panies, particularly smaller ones, to build upcash piles for future investment because of fearthat higher capital requirements on banks willmake it even harder to get credit.

Prof Booth calls for microeconomic measuresto help companies, particularly by further radicalderegulation of the labour market and relievingcompanies of the impending burden of auto-enrol-ment of their staff in pension schemes such asthe National Employment Savings Trust, the low-cost scheme created by the government.

Strategists say that even if the eurozonecrisis provokes a renewed economic downturn,companies should have an eye to opportunitiesas well as simply cutting costs. Research by PAConsulting Group suggests that, in the recessionof 2008-09, companies that saw the crisis as anopportunity to acquire assets cheaply or winmarket share from weakened rivals achieved a10 per cent higher total shareholder return thanthose that did not.

Mark Thomas, business strategy expert at PA,believes companies are poorly prepared for theconsequences of a Greek exit from the euro. “It

is a difficult business to plan for, but I think youneed to do some planning – maybe a centralscenario where things are not so disorderly, andalso an extreme one.”

With or without a eurozone apocalypse, somecompanies see clear virtues in investment evenin difficult times. “We have been investing whileothers have been tightening their belts,” saysMajid Hussain, managing director of AccrolPapers, a maker of kitchen and toilet rolls, basedin Blackburn, Lancashire.

After spending £25m on machines and buildingssince 2005, allowing it to make high-quality papermore cheaply, Accrol plans a further £30m invest-ment in the next two years. Mr Hussain adds:“Perhaps it’s a bit high risk to be investing in arecession period, but for us it’s been paying off.”Additional reporting by Chris Tighe

share from rivals, provided they do so wisely.Some are investing with the help of the gov-

ernment’s £2.4bn Regional Growth Fund, such asDarchem, an engineering business based at Still-ington, near Stockton-on-Tees. It is awaiting con-firmation from its US parent of an £8m invest-ment to create production facilities for specialistfabrication for the new-build nuclear market,towards which the fund has offered £1m.

Graham Payne, managing director, admitsuncertainty over the government’s nuclear powerstation plans is a “big worry”, but says theproposed investment is not a risk. Darchemdoes other nuclear work including insulationand could use the plant for aerospace manufac-turing, too.

Two-thirds of its work is in aerospace, but MrPayne says the nuclear sector will be “one of themost fundamental parts of our future growth inthe next five to 10 years”.

MANY COMPANIES, THOUGH,have been holding back on invest-ment decisions until they seemore light at the end of the tun-nel. “Are they being cautious?

Yes. Are they being irrational? Probably not,”says Lee Hopley, chief economist at EEF, themanufacturers’ organisation.

Richard Jeffrey, chief investment officer atCazenove Capital Management, says the rebuild-ing of balance sheets is a hangover from thecredit crisis, when companies conserved cashbecause they feared they would be denied accessto credit. “This is where they want their balancesheets to be,” he says. “They want to have moreliquid assets; they want more cash because thatis what provides them with reassurance.”

He hopes to see “more significant growth” ininvestment over the next two years than in 2011,when it grew by just 1.2 per cent, but warnsthat when companies spend, they may betempted to invest in higher-growth economiesrather than in the UK.

Mr Jeffrey says that when investment comes,some companies may be doing it from a positionof weakness. “It will be interesting to see whatTesco [the supermarket group] does, for instance.I suspect that when they decide what their futureis going to be, it will require some investment.”

He also warns that if companies hang on totheir cash piles for too long, the government maytry to take them away. “If companies continue togrow their share of national income, there isgoing to be a temptation for government – notjust ours but governments in general – to say weshould be taxing these companies more heavily.”

OnlineContrasting approachesto capital management attwo Manchester-basedcompanies, JamesHalstead and Findel,show the importance forcompanies of keeping ahandle on their finances.ft.com/blueprint

‘Until companies stop stashingthe cash, the economy willremain on the critical list’

Case study Center Parcs

MARTIN DALBY, CHIEFexecutive of Center Parcs, needsno reminding of the value ofinvestment.

“One of the reasons we havebeen successful for the past 25 years is we areforever reinvesting the profits and refreshingthe product,” he says.

The holiday operator has begun constructionon a £250m village – the company’s fifth – onthe Duke of Bedford’s Woburn estate, north ofLondon, buoyed by strong trading and a 97 percent occupancy rate at its four existing sites.

This was no sudden decision. Mr Dalby firstwalked through the greenbelt forest site eightyears ago. A battle against local opponentsensued before planning permission was grantedin September 2007, after initial rejection.

Since then, the company has been divertingfootpaths and bridleways and building newroundabouts. It also took a year to put togetherfinance, of which £100m will come from Black-stone, the group’s private equity owner, and£150m in a construction loan from RBS,Barclays, HSBC and Lloyds Banking Group.

Unlike some companies, Center Parcs did nothave a cash pile. The trigger for the Woburnfunding was refinancing of its £1bn debt, whichhad been due to expire next year. It has beenreplaced by a bond issued via a “whole businesssecuritisation” backed by revenue from itsexisting villages in Cumbria, Nottinghamshire,Suffolk and Wiltshire.

The Woburn Forest site, due to open inspring 2014, will employ 1,200 people in theconstruction stage and 1,500 once it opens.

Mr Dalby has little doubt that there will besufficient demand even if economic growthremains slow.

Center Parcs, which attracts families, has sofar seemed recession-proof: if money is tight,many trade down to the short-break holidays atwhich it excels.

Mr Dalby expects the investment to add 20per cent to Center Parcs’ turnover and 25 percent to its profits. In the year to April 2011, ithad earnings before tax, depreciation and amor-tisation of £131m on revenues of £290.5m.

This will probably be its last site in the UK,where it views its geographical coverage ascomplete.

Ireland remains a strong candidate forexpansion abroad, though Center Parcs endedtalks with the government in Dublin two yearsago after the recession hit. In the long term,Center Parcs is eyeing markets such as Indiaand China.

In the six years since Blackstone boughtCenter Parcs, it has spent more than £250mupgrading the existing villages and will spenda further £60m over the next three years.

Mr Dalby says 60 per cent of customers comeback every three years, so it is important toattract them with well-maintained facilitiesand new restaurants and leisure attractions.Brian Groom

Center Parcs,which attractsfamilies, has sofar seemedrecession-proof

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BLUEPRINT FOR BRITISH BUSINESS | COST CONTROL

OPTIMISTIC, YET STILLdefensive: those are thesentiments expressed by UKfinance chiefs in manage-ment consultancy Deloitte’sCFO Survey for the firstquarter of 2012.

In the first three months ofthis year, optimism among chief financial officersabout the prospects for their own businesses sawits sharpest rise since the quarterly survey beganin 2007 – but that has not yet translated intomore expansionary strategies, such as increasedcapital spend, mergers and acquisitions or intro-duction of new products and services.

Instead, the survey shows that British chieffinancial officers are even more focused on safe-guarding strategies, including cost-reduction pro-grammes, than they were a year ago. Thirty-eightper cent of 136 surveyed indicated that cuttingcosts is a top priority for 2012, compared withthe 31 per cent in last year’s survey.

Ian Stewart, chief economist at Deloitte, isaware of the apparent anomaly of more buoyantbusiness sentiment and still-cautious corporatestrategies. “What we’re seeing is that concernover external uncertainty remains high,” he says.“The consequence of that concern is that the‘new normal’ in terms of corporate behaviour isnot to anticipate any kind of steady upturn inthe near future, but instead to prepare for erraticgrowth for some time to come.”

For now, though, the cuts continue. Forexample, Mothercare, the baby products retailer,has reduced its number of UK stores by 62 overthe past 12 months, and, in April, announcedplans to shut a further 111 by March 2015, result-ing in about 730 job losses. It is also seeking toslash its “non-store overhead costs” by £20m onan annualised basis by March 2015, with the lossof 98 jobs at its UK head office in Watford.

In the financial services sector, meanwhile,HSBC has recently announced that its three-yearturnround plan is on target and that it cut costsby £2bn during the first year of this plan. In thecoming months, it expects to shed 2,217 jobs fromits UK workforce.

But cost-cutting should not just be a responseto difficult market conditions. For some compa-nies, it is simply the way they do business,regardless of the external environment.

“A low-cost position wins in nearly everyindustry,” notes a recent report from Bain, theconsultants. “Cost leaders can out-invest rivals inareas such as research and development andmarketing, while still maintaining attractivemargins. They have the resources to capitalisefaster and more readily on new opportunities.They can capture share, because they have moreprice flexibility.”

But many cost-reduction efforts continue to fallshort of their goals, and relatively few companiessucceed in making the savings they do achievestick, the report adds. A Bain survey of almost300 executives showed that cost-reduction initia-tives launched in 2008 and 2009 in response tothe downturn had reaped disappointing results.Forty per cent of respondents at companies thataimed to reduce costs by at least 10 per centacknowledged that the target was not reached.At companies aiming for ambitious reductions of20 per cent or more, 60 per cent of respondentsadmitted failure.

What can British businesses do to make theircost-reduction strategies more successful?“Ideally, cost-cutting should be a long-termstrategy,” says Clive Lewis, head of enterprise atthe Institute of Chartered Accountants inEngland and Wales.

However, he acknowledged, some companieshad no choice but to cut costs to improve short-term cash flow. “Up to 5 per cent of firms aretrading at a loss and more are heading that way,”he says, and cutting costs now could help themrectify the situation – but only if they makereductions in ways that will not impair the busi-ness’s ability to expand in the future. That meansidentifying areas where cuts will not compromisea company’s unique selling points: its specialistskills, for example, or the quality of its products.

MANY ORGANISATIONSchoose to start this process byreviewing areas of discretionaryspending, including marketingand training budgets. But at

Briggs Equipment UK, the Staffordshire-basedforklift company, chief executive Richard Closetakes issue with this approach. “It is a veryshort-term response,” he says. “You will proba-bly save money, certainly, but you are justavoiding the more painful decision to plan aserious restructuring that would deliver moresustainable savings.”

In 2006, Mr Close was brought in to turn thecompany around, and, by 2011, profits had risento £3m, up from £300,000 in 2010. In part, thatrecovery has been achieved through cost-cutting,he says, and in particular, the 2010 closure of awarehouse relatively far from the company’smain premises.

“I hit an amazing wall of resistance within thecompany when I announced the plans to sell this

second site, but that warehouse was costing us£1m a year to run and was full of unsold inven-tory. My logic was to get rid of the property firstand then the inventory problem would solveitself. Now, turnover has increased, as has ourstock turn rate and I’m saving money that Iwould have otherwise spent on rent and intereston stock,” he says. “It was a structural costsaving, not a tactical quick win. This is whereI think cost-reduction efforts should focus.”

At Cheshire-based Oliver Valves, which manu-factures valves used by companies in the oil andgas industry including Shell, BP and Exxon,chairman Michael Oliver expects cost control tobe a top priority for his procurement team, justas it was for him when he started the companyin his garage back in 1979.

In their negotiations with UK-based steel suppli-ers, they offer the companies guaranteed ordersfor the coming year, but on three conditions: thesuppliers must keep the steel on their own siteuntil it is needed at Oliver Valves; they mustensure that it is pre-certified for quality by inde-pendent assessors; and they must offer discountsto Oliver Valves that reflect the volumes thecompany orders.

The company also works with a wide pool ofinternational suppliers. It has a procurementteam in India that deals directly with localsuppliers, regularly achieving 30 per cent costsavings on components compared with the pricesoffered by UK suppliers.

“We know to the penny what our costs are –and I mean to the penny,” says Mr Oliver. “Wehave a saying here that ‘gross margin is king’, sowe simply don’t accept an order in the first placeif it doesn’t offer us a gross margin of at least 50per cent. If you don’t understand your costsreally thoroughly, you’re not running your busi-ness well. It’s as simple as that.”

Reduction in expenditure can generate cash f low, and even finance growth, finds Jessica Twentyman

Cutting back to the bottom line

‘Gross margin is king – if youdo not understand your costsreally thoroughly, you are notrunning your business well’

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BLUEPRINT FOR BRITISH BUSINESS | CASH FLOW

WHEN THE DOWN-turn struck, Boothswas better preparedthan many busi-nesses in the UK.The family-ownedgrocery chain,which operates 28

stores in the north-west of England, hasbeen part of the retail landscape since 1847and has seen its share of peaks and troughsin the economic cycle.

The fallout from the credit crisis of 2008 wasnot immediately noticeable in Booths’ businessfortunes, says John Vandermeer, finance director.“People still appeared to have money in theirpockets, especially as our customers tend to beamong the more affluent,” he says. “It’s really inthe past 12 months that we’ve begun to seesome impact. Unemployment and fuel costshave begun to affect spending habits.”

Booths was fortunate last year, too,when it sought refinancing to helpfund expansion. “The banks havealways seemed to have an appetitefor what we’re trying to achieve,”Mr Vandermeer continues, “althoughour original bank did suggest we bringsome others on board.”

Other British companies, however, haveenjoyed less success when they went to thebank. The total value of loans to private, non-financial companies dropped by £1.7bn inMarch, according to the Bank of England, andoverall lending to businesses is falling by morethan 3 per cent a year.

For many businesses, credit has all but driedup in the years since the financial crisis, forcingthem to rethink how to manage their cash flowand liquidity – or perish.

“If you go back to the pre-crisis period, youwouldn’t see businesses placing the amount ofemphasis on cash flow and working capitalmanagement that they are now,” says LesleyWhite, head of Europe, Middle East and Asiatreasury products for corporates at Bank ofAmerica Merrill Lynch.

“Post-crisis, with bank lending much tighter,the importance of effective, efficient cash-flowmanagement has increased. Cash flow is the lifeblood of the business.”

There are signs that companies – especially inthe UK – are adapting to this reality. Accordingto Treasury Strategies, a financial consultancy,UK-based companies have been building largerpiles of cash than their counterparts in the USand eurozone since well before the credit crunchbegan. Cash held by British companies amountedto 50 per cent of the UK’s gross domestic productat the end of 2011, compared with 26 per cent in2000, Treasury Strategies says.

By contrast, US corporate cash wasabout 14 per cent of GDP at theend of 2011 compared with 10per cent in 2000, and eurozonecompanies’ cash was 21 percent versus 15 per cent.

“It could be that UK compa-nies are generally more con-servative in their approach tocash,” says Monie Lindsey, man-aging director and head of the Lon-don office of Treasury Strategies. “But2008 madeeverybody more cautious, and whether you callit hoarding or insurance, companies don’t want toget caught out.”

Nevertheless, banks’ continued reluctance toextend credit is forcing companies to cast theirnet much wider to secure the cash they need.

Clive Lewis, head of enterprise at the Instituteof Chartered Accountants in England and Wales,says: “There is a general understanding amongbusinesses of the importance of cash flow. Many

companies have raised it on their priority list.“But businesses need to remember that there is

a whole range of finance options. Term loans andoverdrafts are still very popular. But they shouldalso consider options such as asset finance, hirepurchase and leasing, invoice discounting and,for some, equity.”

Mr Lewis adds: “It boils down to basic, goodfinancial management. And you need to talkabout it regularly in board meetings andmake sure you have a high standard of financialforecasting.”

Ms White at Bank of America Merrill Lynchsays companies are also reorganising their inter-nal processes, supported by systems to improvetheir cash flow. “Anybody who had a crystal ballin 2007-08 would probably have renegotiated their

finance conditions before the crisis, evenif they weren’t up for renewal,” she

says. “But treasurers also need tomake sure they are looking at

all aspects of their businessimpacting working capitalmanagement, including supplychain and inventory, toensure that cash ismanaged properly.

“Whether you are amedium-sized corporate or a

large multinational, there is a lotof emphasis on how to be more

efficient when it comes to cash-flowmanagement, and understanding the profit andloss impact of the supply chain,” she says.“This could mean negotiating better terms withsuppliers. Sometimes just moving paymentmethods from paper to electronic will make adifference, or moving to other available instru-ments, such as direct debits.”

COMPANIES ALSO NEED TOconsider whether their cash pile isbeing put to best use. Jose Franco,global head of corporate banking liquid-ity at Bank of America Merrill Lynch,

says: “With all the uncertainty in the market, a‘fortress balance sheet’ is vital. But there is thethreat that it will be eaten up by inflation due tothe low [interest] rate environment.”

This is why an effective cash-flow managementstrategy also involves investment. “Cash flowand investment strategy go hand in handbecause the stockpile of cash causes otherchallenges,” says Mr Franco.

“Cash can be classified as operating cash,which is needed immediately; reserve, which isneeded in a 6-12 month window; and strategic,which isn’t needed so can be invested for thelonger term. That investment could be in aninstrument or it could be in purchasing one ofyour suppliers, or even a similar business inanother geography. But the critical point is thatnot all cash should be treated as operating,”

he explains.Mr Franco adds that the emphasis on effec-

tive cash-flow management is likely to remaina focus for businesses for the foreseeablefuture. “It wasn’t critical when credit wascheap,” he says, “but risk appetite will also

become more important in the next five yearsas interest rates rise. The UK and the US are in

a strong position, Europe is challenged.”At Booths, Mr Vandermeer says the company’s

refinancing has secured funding for the nextfour and a half years. But he says an under-standing of cash flow is critical to ensure thatthe company does not overextend itself in itsexpansion plans.

“We have seven or eight stores in the pipeline,and there are a lot of factors that will impactwhen a new store build will come through,” hesays. “But a lot of the control is still within ourremit, which helps an awful lot from a cash-flowplanning point of view.”

In an era of austerity, a strong balance sheet is vital, says Paul Solman

Show me the moneyBLUEPRINT FOR BRITISH BUSINESS | SMALLER COMPANIES

Businesses have been forced torethink how to manage their cashflow and liquidity – or perish

FOR MOST ENTREPRENEUR-led businesses, capital manage-ment is one problem theywould actually like to have.

Young businesses do not gen-erally have huge cash piles.The first few years is usually ahand-to-mouth existence, saving

money wherever possible and spending what-ever money is available building operations.

Those that survive can start to think aboutselecting a finance team to take charge of theircapital management. However, most managewithout a finance director, instead relying onfinancial controllers or even book-keepers.

The financial crisis created a double blow formany entrepreneurial businesses – not only didthey have to cope with the implications of asudden drop in demand for their product orservice but the credit to support their opera-tions became harder to come by.

Stats Group, an Aberdeen-based engineeringbusiness that provides tools for oil and gas com-panies to isolate sections of their pipelines fortesting, had been growing between 50 and 100per cent in the four years leading up to the col-lapse of Lehman Brothers in September 2008. Inthe next year, however, its revenue fell from£16m to £9m, forcing it to cut its headcountfrom about 140 people to 80.

Although its oil market quickly recovered,Stats, which up until then had been wholly debtfunded, faced problems getting the working cap-ital it needed to rebuild its capacity.

“The reality was that it was an awful rockbottom that led us to be very constrained,”Peter Duguid, Stats’ chief executive recalls. “Wehad to reassess our levels of debt. Certainly,from an entrepreneurial perspective, my focuson the day-to-day management of cash wasfront and centre.”

Stats recovered its position, rebuilding itsworkforce to previous levels and returning tostrong top-line growth. Revenue this year isexpected to be £25m, up from £14m in 2011.However, it has not been easy, Mr Duguid says:“When you are a niche engineering businessyou need very specialist design experts, so whenyou let some of those go, it is quite detrimentalto the business.”

In March this year, Stats accepted a £7.8minvestment from the Business Growth Fund, abank-financed venture capital fund. The rela-tionship has alreadyproduced results, withthe BGF helping Statsfind a non-executivechairman and financedirector to lead thefinance team.

It is this support, asmuch as the funding, that has made the rela-tionship with the BGF worthwhile, Mr Duguidsays. “What I see is stronger internal disciplines,stronger accountability in the internal functionsof the business and probably stronger bankingrelationships,” he says. “I have far better visibil-ity [of what is happening in the business] with-out doing more myself.”

If there has been a benefit from the financialcrisis it is that many entrepreneurial businesseshave been forced to reassess their reliance ondebt and how they manage available capital.

Guy Rigby, head of entrepreneurs at account-ancy firm Smith & Williamson, says: “There isan old saying: don’t borrow short to invest long.In practice this means having both fixed capital(also known as equity) and debt in the business.”

The level of debt capacity of a business willdepend upon the availability of cash flow toservice the interest and capital payments, MrRigby notes. “Overdrafts, which are repayableon demand, should be fully fluctuating. In otherwords the account should swing into credit

from time to time and the debt should not bepermanently bumping up against the facility.”

He says small businesses are generally notvery good at managing banking relationships.“The banks and the businesses are divided by acommon language. Entrepreneurs talk visionand the future. Bankers talk cash and now.”

Reliance Fibres, a London-based paper recy-cling business, trades in seven countries, butgets almost all of its £12m annual revenue fromexports to India. As a result, it needs currencyhedging support and a large amount of workingcapital to buy stock. It also needs to ensurethat invoices are settled quickly and thatsuppliers are paid on time.

Good banking support is essential, as is adiligent finance director, according to PankajChowdhary, founder and chief executive. “Forus, managing cash is all about rolling it assoon as you can,” he explains. “One thing wemake sure of is that we don’t pay anybody upfront. We squeeze as much as we can out ofour credit limit with suppliers and get as muchfinance as possible from our buyers.”

Reliance buys its raw materials from largewaste management companies, many of themfamily-owned businesses that are careful aboutwhom they deal with. As a result, Reliance hashad to make sure its reputation is exemplary.Being UK-based helps in this regard, Mr Chowd-hary notes. It also helps that the businessbanks with HSBC, which has made Relianceone of the small businesses it promotes. “Repu-tation is first and foremost for us,” he says.

W HILE ACCESS TO FINANCEremains a struggle for manyentrepreneurial businesses,alternatives have appeared toenable companies to bypass the

banks. Some companies, such as men’s toilet-ries business King of Shaves and confectionerybusiness Hotel Chocolat, have turned to cus-tomers for funding via retail bonds.

The digital age has also created a variety ofnew business models and technologies that canhelp them in this process, such as peer-to-peerlending and short-term loans available at theswipe of a smartphone screen.

According to Tony Cohen, head of entrepre-neurial business at Deloitte, the accountancyfirm, the danger for many young growingbusinesses is that they get too caught up in the

short-term requirementsof credit control and somiss out on fundingopportunities that couldincrease their cashbalances.

“There is lots of workaround creditor terms,

cash collection and cash flow, but they are sofocused on what they are doing day-to-day thatthey haven’t the time to think more broadlyabout where they might be able to get somefunds in the future,” he explains.

Larger companies, on the other hand, areinherently better at managing working capital.They also have significant power over smallerbusinesses they buy from or sell to.

It might seem unfair to those on the receivingend, but it also forces these smaller companiesto use their entrepreneurial skills to managetheir cash wisely as well as grow their busi-nesses, according to Julian Ramsey, a director atErnst & Young, the accountancy firm. Smallerbusinesses should not see themselves as victims.Being small actually has its advantages, he says.

“The most successful entrepreneurial busi-nesses focus on better management of theperipheral – rather than the headline – termsrelating to cash in contracts,” he says, “less onwhether payment is in 30 or 60 days and moreon rebates and payment frequencies.”

A capital ideaStart-ups need banking support, writes Jonathan Moules

‘Banks and businessesare divided by acommon language’

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BLUEPRINT FOR BRITISH BUSINESS | CURRENCIES

THE PERCEIVED HAVEN prop-erties of sterling oninternational currencymarkets generate a clearproblem for British business:a strong pound makes exportsmore expensive.

At a time when domesticdemand is also under pressure from falteringconsumer confidence and a return to recession,the impact of adverse currency movements oncompetitiveness abroad adds a fresh layer ofdifficulty.

For companies, this makes mitigating theimpact of a strengthening pound all the moreimportant, and there are four main types offinancial instruments that can be utilised tosoften the blow.

Options contracts come in two types. “Call”options give a company the right, but not theobligation, to buy a currency at a predeterminedprice within a defined time frame. A “put” optionallows the company to sell at a certain price, andwithin a defined time frame.

Futures contracts provide a standardised wayto buy or sell currency at a set price and a settime, both defined at the time the contract isdrawn up. Because the contracts are standard-ised, they can be subsequently traded onexchanges.

Forward contracts work in a similar way, andtend to be drawn up between banks or brokers,with the price of the sale or purchase also agreedat the time the contract is written. But becausethey are private contracts, they cannot be tradedamong third parties on open exchanges.

Carry spot trades allow companies to take longor short bets on the value of a currency, fundedin another, in order to gain positive exposure toa relative change in value that might otherwiseadd to a business’s costs.

Michael Stumm, co-founder of OandaCorporation, the operator of the fxTrade website,offers an example. “You are a small company inthe UK that has an accounts payable of €250,000,due in three months,” he says. “In order to pro-tect yourself, you can buy €250,000 using sterling,thereby eliminating any currency exchange risk,since you will be getting today’s rate. It doesn’tmatter if the euro goes up in value or down asyou are controlling a €250,000 euro position inyour account thus ensuring you have hedged thefull amount of the pending payable.”

The impact of such strategies on business canbe significant, and the current volatility onforeign exchange markets means they are becom-ing more popular.

Philip Evans, director of strategy and businessdevelopment at Ramsden International, a foodexporter, is looking into adopting hedges, andsays the currency market is becoming “moreinfluential” as the business grows.

“Historically, we have sold only in sterling.But customers’ memories tend to only go back ayear or so, and as we need to avoid lookinguncompetitive, exchange rates are becomingmore of an issue. For some larger customerswe now need to invoice in local currencies,but with longer-term contracts, with paymentterms of up to 90 days, you have to evaluatefactors influencing margins, and the volatilityof the currency market is an important partof that. It’s not all easily predictable. Theissue is one of balancing competitivenessand risk and that has started to moveagainst exporters.”

Sarah French, finance manager atIT4Automation, started using currencyhedging four years ago, after becomingaware that the business, which distributesnetworking products, was paying morethan it needed to in euros for productsbought from Taiwan.

“We brought in specialist help to reduce thefrequency with which we had to revise prices,as well as to keep down our euro-costs. Wewere not getting a great exchange ratethrough the banks, and we also had to paytransaction costs.

“The services offered by our hedging pro-vider have been more flexible andoffer us greater clarity. I havethree forward positions at themoment, and can look atthem at any time. For us,it definitely has worked,and has also been costeffective. If I wasmarking our strategy outof 10, I would give it anine, although we remainaware there is an elementof risk, and the [currency]price can always goagainst us.”

One chief executive ofa medium-sized companybased in the south-east ofBritain says that thepound’s ascentwould need tobe steeperbefore it becamenecessary for hisbusiness to takeaction. Healso saysthat manyexporters buyparts or rawmaterials fromabroad, whichcan act as whathe termed “aninternal hedge”against a strongpound.

Oanda’s MrStumm points outthat some hedgingstrategies are morecomplicated thanothers: “Bankstypically generate

more revenue from selling options than fromselling the other instruments used in hedging.

“Options are relatively complex derivatives,and unless you fully understand the mathsbehind options pricing, you cannot know if youare getting a good deal or not. Hence, we recom-mend clients stay away from options unless theyhave a financial background.”

Angus Campbell, head of market analysis atLondon Capital Group, said the demand for thehedging services he provides is growing as thecurrency markets remain turbulent.

“With the outlook for the eurozone still veryunclear, we would expect to see more clients useour foreign exchange platform for hedging pur-poses. A simple and effective way for exportersto mitigate risk is to buy or sell those currenciesthat they are exposed to in order to protectthemselves against any adverse fluctuation in theexchange rate.”

Companies can use financial instruments to guard against a strong pound, says Michael Hunter

Hedging your bets

‘With the outlook for theeurozone still unclear, we expectmore clients to use foreignexchange platforms for hedging’

10 FINANCIAL TIMES THURSDAY MAY 31 2012 FINANCIAL TIMES THURSDAY MAY 31 2012 11

BLUEPRINT FOR BRITISH BUSINESS | MANUFACTURING

Companies can no longer rely on bank lending – but are coping surprisingly well. By Michael Kavanagh

Beyond the bean counters

BLUEPRINT FOR BRITISH BUSINESS | OPINION

In a reversal of positions, cash-rich companies are concernedabout the health of the banks

Jonathan Guthrie A doomed golden age for UK plc

WALLS OF CASH OFTEN PROVEless durable than the kind madeof bricks and mortar. Prudentbusinesses build up cash or paydown debt when performance has

been strong, lest it disappoints later on. That isthe position of many large businesses as continu-ing eurozone turbulence – most recently mani-fested in Spain’s property crash – threatens todepress growth further. The dissipation of thesereserves through cost subsidies during periods oftougher trading or, indirectly, through bankdeleveraging mean that their impact is rarely asdramatic as suggested by such bald numbers asthe $2tn of surplus liquidity reputedly lurking onthe balance sheets of US and European compa-nies at the end of 2011.

European politicians would it were otherwise.Most of them believe, with varying degrees offundamentalism, that austerity is the only routeto post-financial crisis stability and then growth.The implicit contradiction is that many of thetribunes of the people would nevertheless likecompanies to make the stimulatory investmentsseen as inadvisable for the public sector becauseof its higher indebtedness.

Unsurprisingly, company boards remain scepti-cal that their hurdle rates for investment can besurpassed when spiking yields for Mediterra-nean government debt point to a longperiod of turbulence and weakgrowth. For example, the UK’sOffice for Budget Responsibil-ity, an independent fore-caster, expects output togrind along at below 3per cent a year until2015.

In a recent note, Mor-gan Stanley, the invest-ment bank, argues thatan improvement in theavailability of credit isneeded to stimulateinvestment even whencompany balance sheets arehealthy. A loans droughtweakens collective economicconfidence, even among those whodo not want to borrow, the argumentruns. European banks are shrinking theirbalance sheets as they write down dud loans andseek to meet tougher capital requirements, so norecovery is likely soon. After the decade hubristi-cally dubbed “nice” (non-inflationary, constantlyexpanding) come the years of collective paralysis.

Business has at least benefited from a recoverythat came in the wake of the credit crunch andwas propelled by such engines as restocking andunrepeatably rampant Chinese growth. UK corpo-rate earnings before interest, tax, depreciationand amortisation as a percentage of sales rosefrom 9.9 per cent in 2008 to 15.4 per cent in 2011,but slipped to 13.5 per cent in the last quarter,according to the S&P Capital IQ database. Thedread hand of mean reversion weighs heavily onthe shoulder of business.

For bosses, investment cycles are overlaid bytheir own career plans. If you are not intendingto stick around – or fear that increasingly asser-tive investors might provide you with an expe-dited exit – the temptation is to forget about

capital expenditure and bolster payouts to share-holders instead. Similarly, no stock analyst evergot fired for short-termism. BT Group, the tele-communications company, recently suffered Citycriticism for raising its final dividend by 12 percent. This increment was regarded as derisorywhen a higher total could have been achieved bythe simple expedient of spending less on the roll-out of faster broadband, a cost that promises tobenefit both BT and the broader economy.

MANY BILLIONS OF THEputative wall of cash have beenreturned to shareholders. There isplenty more to come. UK listedcompanies paid gross dividends of

£68bn in 2011, according to Capita Registrars, theUK administrator of company share registers.This is a 19.4 per cent increase and the highestfigure for five years and the company’s forecastfor 2012 is £76bn.

Shareholders reasonably expect that a one-offgain by a company should mean a one-off

payout to them. More broadly, extem-pore returns of capital are a signal

that current rates of return.Share buybacks have been a

sop to investors over the pastcouple of years, despite thereasonable objection thatrepurchases represent poorvalue when made, as is cus-tomary, during market ral-lies. Buybacks are automat-ically earnings enhancingand tax free for continuing

investors, who are thushappy to ignore the critics.Takeovers – another use

for corporate cash – have bycontrast been notable for their

scarcity. Here, as with investmentin organic growth, a heightened percep-

tion of risk is to blame. Meanwhile, privateequity companies, reliable purchasers of publiclylisted companies before the crunch, have sufferedthe double indignity of tighter credit and aboycott by equity funders of the weakest oftheir number.

Raising top-line growth through mergers andacquisitions is a long-standing, if unspoken,strategy of chief executives hungry for a payincrease. With that avenue blocked, they can atleast expect the boost to remuneration thatspecial payouts should deliver via bonus formulaeshackled to total returns. But, as UK shareholdersseize back the ownership that was always theirsfor the taking, bosses can no longer look forwardto the upward rebasing of their pay. All in all, forboth executives and investors, there is just a hintof a doomed golden-age vibe to cash-rich 2012. Itis appropriate that a remake of The Great Gatsbywill be released this year.

Jonathan Guthrie is the FT’s City editor

A loans droughtweakens collectiveeconomic confidence

ued pressure on the UK high street, the companyis thriving – it is the banks he is worried about.

“We are in a strong position. We are aprofitable company with a strong customerbase,” he says. “And shopping groups are, withone or two exceptions, creditworthy.”

But the general fragility of the UK andEuropean economies has continued to threatenthe amount of help many businesses can expectto receive from clearing banks as the threat ofa double-dip recession looms.

“We have a variety of credit lines. We are notdeciding against doing anything because of ashortage of cash,” says Mr Mills. “But we havebeen diversifying our banking facilities – we arenervous and there is safety in numbers.”

Instead, the main constraint on trade, he says,is the general lack of confidence in economicdemand in the UK and continental Europe,which accounts for the bulk of the 40 per centof JML’s sales not generated in the UK.

“The corporate sector is strong in cash, thoughsome are now struggling, while some continue toexpand,” he says. “If you have an economy thatis shrinking, the average business is not goingto expand – it is very difficult to convince peopleto invest if there is no prospect of recovery inthe future.”

Though Brompton has enjoyed success inexpanding exports, sterling’s recent appreciationagainst a weakening euro has forced the com-pany to impose a mid-year price increase on itsrange of folding bikes destined for the continent,which accounts for about 40 per cent of sales.Much of its business is naturally hedged, as theproportion of sales made in the eurozone ismatched by the proportion of parts priced ineuros – just as parts sourced in Asia and pricedin dollars are matched by dollar-pegged receipts.

And Mr Butler-Adams argues that businessescaught by surprise in the last recession arebetter prepared in general to face the nextphase of difficulties. “Businesses struggling threeyears ago have gone bust or done something tomake their situation better. But we have to getout and export. There is no recovery comingfrom the UK – or Europe.”

Plans for a new shop in Shanghai reflectbooming Asian prospects, and new sales anddistribution leads are being pursued in SouthAmerica. Business in the US remains positive.And even in the flatlining economies of Europe,Brompton’s cult status still leaves the companykeen to invest in expansion – if paid for out ofits own resources.

For Mr Mills, though, his company’s success innavigating the “sink or swim” conditions facingmany UK mid-tier businesses still leaves Britainfacing an economic policy disaster leading tohigh unemployment, stagnant living standardsand a manufacturing decline prompted by adefence of sterling.

“The real route to re-establishing the scale ofinvestment needed to create a manufacturingrenaissance in the UK is a devaluation of ster-ling,” says Mr Mills, who apart from establishinghis own business is also former Labour financechief of Camden Council in London.

As an importer of many consumer goodsmanufactured in east Asia and denominatedin dollars, he is aware that his key policyprescription – effectively the same devaluationargument some support to revive the Greekeconomy – would hurt the cost base of his ownbusiness in the short term.

“But it is what is best for Britain, not JML,”he says. “If the exchange rate did go down, weare experienced enough to overcome this prob-lem. Life would be difficult but not terminallydamaging – it is what is best for the country.”

WHILE BRITAIN’Spolitical and bankingleaders contemplatethe extent of thedamage that mightbe inflicted on thedomestic economy bythe eurozone crisis,

those supplying manufactured goods for sale orexport would do well to keep calm and carry on.

For Will Butler-Adams, managing director ofBrompton Bicycle, a stagnation of high streetspending in the UK and European slowdown hasnot hindered 20 per cent year-on-year growth insales of its niche range of folding bikes that cancost more than £800.

But the company, one of Britain’s few remain-ing bicycle manufacturers in a sector dominatedby east Asian suppliers, is typical of many smallbusinesses that successfully navigated the finan-cial crisis and subsequent recession of 2009. Likemany of its small and medium-sized enterprise(SME) peers, it is pondering investment, butwary of relying on bank borrowing to do so.

Investment plans for Brompton – whichinclude new factory space for expanded produc-tion and a first store in China – are tempered bythe desire to maintain a £1m buffer within largercash balances.

“We have £2.5m in the bank,” Mr Butler-Adams says. “Four years ago we were operatingin the red – now we want £1m in the bankas a minimum against [problems] and ifthe banks don’t lend – and another £1.5m toplay with.”

Mr Butler-Adams’ reluctance to rely on bankborrowing even during a phase of expandingexport-led sales growth might appear overly con-servative to many. Surely it is precisely at suchtimes that businesses ought to be borrowingrather than hoarding cash?

But such an approach appears to fit a patternof fractured trust between the SME sector andbanks. Created during the crisis of 2008-09, it hasyet to heal. Now the relationship is threatenedstill further by nervousness over the futurewillingness and ability of banks to extend creditas the eurozone crisis deepens.

A report commissioned by the Institute ofChartered Accountants for England and Walesinto access to finance for SMEs, published earlylast year, concluded the majority of respondentsfelt that “whatever trust existed between banksand SMEs in 2009 has mainly dissipated, due tothe ways SMEs have been treated by banks inthe last nine to 12 months, in particular whenseeking finances”.

It added: “Most feel that there is currently noreal ‘relationship’ between the banks and theirSME clients. Any relationship, such as it is, ismainly seen as weak or poor, and certainlyworse than it was before the credit crunch.”

Learning to live without lending frombanks appears to be a pattern that has stuckfor many companies, regardless of their credit-worthiness. And, in a reversal of positions, cash-rich companies are now concerned about thehealth of the banks.

The latest quarterly SME finance monitorpublished by BDRC Continental, the consultancy,suggested there was an increasing proportion ofmedium and smaller businesses who were “happynon-seekers” of bank lending, who had neitherapplied for finance nor wanted or needed to.

“There is a lack of trust in the banks in thismarket,” confirms Mr Butler-Adams. “There isa very uncertain situation in Europe – we arenot out of the woods.”

Concern over the health of banks exposed tolarge-scale defaults in Europe has also provokeda defensive financial strategy at JML, theconsumer goods distributor.

More than three years on from the demise ofone of its best-known outlets, Woolworths, JML’sfounder John Mills argues that in spite of contin-

12 FINANCIAL TIMES THURSDAY MAY 31 2012