Without properly managing their working capital, new ventures stand little chance of surviving, writes Caroline Madden.

In the world of business, it is sometimes said that turnover is vanity, profit is sanity, but cash is king. Trouble-shooter Alan Morris believes there is no truer adage, particularly when it comes to start-up businesses.

Morris works as a director in the restructuring department of accountancy firm KPMG in Dublin, and deals on a daily basis with companies that have run into difficulty. One of the most common problems he encounters is undercapitalisation, which simply means that a business does not have adequate funds to support its activities.

The reason that companies fail to raise enough capital is that they don't fully understand the cash-flow requirements of their business, he says. As the name suggests, cash-flow refers to the movement of money in and out of the business.

Effective cash-flow management is vital to the survival of any business. Without enough cash at hand to pay debtors, wages and other overheads, it doesn't take long for a venture to go under.

The cash-flow of a business can be improved by focusing on its working capital cycle - ie, the length of time it takes to convert cash into goods or services, sell those goods or services and get paid for them. The working capital requirement of a company is the amount needed to meet the day-to-day operating costs of this business, and this requirement varies by sector.

Operators in the construction industry can struggle with their working capital cycle, he says, because their suppliers and subcontractors generally require speedy payment, perhaps weekly, whereas it can take 60 days or more to negotiate and receive payment from their client for work completed in a given period of time. Therefore the working capital required to tide them over this time lag can be quite high.

"You've got to look at cash conversion - how quickly can you convert your work done into cash?" advises Morris.

Businesses that expand very rapidly often run into the problem of overtrading. New sales or contracts may be piling in thick and fast, but if a company can't actually fund the additional working capital requirements, it will soon get into trouble.

Debt collection is another area that start-ups can struggle with. Under legislation, companies are entitled to charge interest on payments that are not made on time, but Morris says that it's difficult for small businesses to carry this out in practice. An imbalance of power often exists between the small supplier and large customers, who are aware that the company cannot afford to lose their custom.

Overdependence on a small number of customers can be a recipe for disaster. This can be seen in the construction sector, where the failure of one large firm will have a ripple effect down through the chain of its suppliers and subcontractors. "All it takes for that one contractual customer to go wrong and you're in big trouble," says Morris.

Another common pitfall is lack of financial management information. Companies need to be able to identify which of their customers are making them a profit. Similarly, if they are making a number of different products, or providing several services, it is essential to know which of these are in fact profitable, and generating cash.

If a company finds itself facing a cash-flow crisis, advisors such as KPMG will bring its management right back to basics, help them to understand the working capital cycle, put a cash-flow forecasting system in place and advise them on how to free up cash in order to keep the business afloat and avoid insolvency.

A cost-cutting exercise will usually be carried out. "Businesses generally have a bit of slack in them," Morris says. "You can look at pushing out your supplier payment terms. You can look at ways of collecting your debt sooner."

Another key issue that all businesses must attend to is their finance package. Overdraft facilities should be used only to negotiate the troughs in the cash-flow cycle, but should not be used in the ordinary course of business, he says, as an overdraft is an expensive form of finance. Companies should consider fixed-term loans for asset purchases, and should also investigate whether they are entitled to any grants.

So is it possible to salvage a company that has fallen into these common traps and is now on the brink of going broke? "It is, but the key to achieving a successful turnaround is to get in early," Morris says.

If a company starts running into problems, the sooner it seeks advice and support the better the chance of surviving.