Developing a temp business has all the financial demands of any business, however it is amplified by the cashflow implications of weekly payroll, versus invoices that are payable in 30 days plus. This is a ‘hairy’ business, if not carefully managed as very quickly, payroll can result in significant cashflow issues if working capital isn’t properly funded and managed. For this reason developing your temp business with a view to growth, expansion and potentially to create value for a sale has its complexities. Primarily that complexity revolves around working capital and cash flow management.
What is working capital?
Working capital represents the amount of money a company has left over after accounting for all expenses to be incurred within the next 12 months. It is calculated by subtracting current liabilities from current assets, so it is a reflection of a company’s short-term liquidity and operational efficiency. Of course in a business that pays its temporary contractors weekly, its weekly liability versus its income can be significant.
More working capital equals less financial strain
A positive calculation shows creditors and investors that the company is able to generate enough from operations to pay for its current obligations with current assets. A large positive measurement could also mean that the business has available capital to expand rapidly without taking on new, additional debt or investors. It can fund its own expansion through its current growing operations.
A negative net working capital, on the other hand, shows creditors and investors that the operations of the business aren’t producing enough to support the business’ current debts. This isn’t necessarily a bad thing, if there is good reason for it, it is recognised by obtaining investment or a loan or invoice discounting. What is more important is that over a period of time the trend improves.
Calculating working capital requirement
The below example is based on a temp agency with circa 60 temps out a week, 25 per cent margin, 30 day payment terms and demonstrates a working capital requirement of circa £190k.
Ways to improve working capital over time;
1) Increase sales and profitability, bringing more cash in to the business. Particularly the volume of temps out and temp margin percentage (i.e. the amount made for every pound of sales after allowing for wages and on-costs such as ERNIC, Pensions and Apprenticeship Levy).
2) Improve debt collection. It is essential that a formal approach to credit management is instilled within the culture of the business. Terms of business and credit checking are a must. Longer credit terms should be offered only in return for improved volumes and higher margins. Debt has a cost and needs to be factored in to pricing. A strong focus on debt collection is essential and generally outsourced credit collection may prove more effective and efficient if managed well.
3) Negotiate longer payment terms with suppliers and ideally with temps, though depending on the sector and what is the norm for that sector this may not be possible.
Own money – if you have your own money and you believe in yourself and your business, then investing in your own business will save you the cost of debt and will keep your business 100 per cent to yourself.
Investor money – this can come in the form of Private Equity or so called angel investors. With these, they are taking significant risk and so be prepared to give up a percentage of your business and you may have to report regularly to them. When considering this, your relationship with the investor will be important and you should think carefully about how you will feel in six years’ time and are giving away say 60 per cent of your profits. Though a necessary evil if you can’t raise the funds any other way.
Loans – of course, if you are able to persuade the bank you can take on a loan. Obviously this will have incur interest costs but will mean that you do not have to give up any equity.
Invoice Discounting – this is a very popular way for recruitment businesses, without giving away equity, can fund the working capital of a temp business on an ongoing basis. There are lots of banks and financiers offering such services at varying costs so shop around.
How to gain investment capital
No matter which method of funding you choose, the basic fundamentals of forecasting and cashflow management will apply in all cases. To convince yourself or any other stakeholder, be prepared to professionally manage your business using KPIs, profitability forecasting, pipeline management and cashflow. Quality accountants are worth their weight in gold here, a basic book-keeper won’t cut it and I have seen many a business get into trouble due to their failure to manage their working capital and cashflow properly.
Profitability forecasting and cashflow management
In order to attract an investor or indeed satisfy a bank or invoice discounting facility, the recruiter will need to demonstrate that the business is viable and has potential for growth. This can be done in the form of firstly a profitability forecast and then this in turn can be used to generate cashflow projections.
The easy items to project are things like expenses – rent and rates are fairly fixed and headcount, if controlled, is also easy to predict. More difficult to forecast is the volume of temps out and therefore predicted turnover and margin. Historic trends are a good starting point and take into account seasonality. A strong pipeline is also key to forecasting, but prepared to be questioned hard on the how realistic your pipeline really is. Allocating a likelihood probability and continuously revising your view on this can help weed out unrealistic expectations.
Key performance indicators
I can’t recommend highly enough the importance of tracking KPIs, in order to demonstrate to investors the disciplines that you operate. KPIs may include; Number of temps out daily, Average charge rates, pay rates, margin percentage, sales calls, number of clients, number of candidates, fulfilment. These KPIs can be used in pipeline creation, forecasting and cashflow predictions.
Unfortunately, being a good temp consultant, building client relationships and putting candidates in to placements and filling contracts just isn’t enough. You ignore the financial side of your business at your peril. The good news is, there are plenty of experts around to support you and you should always choose an accountant that specialises in recruitment business. A high street accountant is very unlikely to understand the pace and working capital requirements, combined with client, contractor and compliance demands that are specific to recruitment temp businesses.
Numbermill is a specialist accountancy firm advising recruitment business with regards to financial strategy, back office outsourced efficiency, due diligence for growth and potentially business exit. Louise Rayner is an FCCA chartered accountant who has held board level positions in a number of recruitment businesses including Randstad ad Adecco. In 2015 she led the successful sale of an £80 million turnover recruitment business in which she held a share, to Staffline group.