A recent study by analytics firm Vector Scorecard and National University of Singapore Business school found that a higher proportion of companies that are well managed or attain higher financial ratings tend to dominate public-sector projects.
This study was timely and appropriate given the recent spate of work stoppages and delays due to contractors of infrastructure projects facing financial difficulties in Singapore.
As a result, public sector entities can be expected to be extra prudent and diligent when awarding contracts.
On the other hand, the study also noted that "financial criteria by the agencies have not been set upfront."
This could mean a guessing game for SMEs who wish to succeed in their tenders. How do you win a game if you do not know what the scoring system is?
It went on to say that a firm's financial sustainability helps predict its success in winning public tenders and that SMEs are advised to analyse their own balance sheets.
In the absence of detailed and upfront financial criteria being specified by agencies, how can SMEs prepare themselves to succeed in this tender game? How is financial sustainability determined?
SMEs should begin by studying their balance sheets. The balance sheet indicates financial strength. The three basic elements of a balance sheet are assets, liabilities, and equity (also called net worth).
First look at equity. If this is negative, potentially the business is technically insolvent. The reason is even if all the assets are sold and turned fully into cash, the amount is still insufficient to pay off liabilities, resulting in negative net worth. This would be a big red flag to agencies.
Secondly, assuming that equity is positive, take total liabilities and divide by equity. Preferably this number is below 0.5. For example, if total liabilities equal one and equity is two, the ratio of total debt to equity would be 0.5. This means that for each dollar the business owes, shareholders have put in two dollars into the business. This would provide creditors a margin of safety.
If liabilities are too high, reduce them and increase equity. First thing to do is look at the type of liabilities. If there are amounts owing to shareholders and owner-directors, consider converting them into shares. This will reduce liabilities and increase equity without further capital injection
The other alternative is for shareholders to pump in more cash as additional equity. This process is known as "strengthening the balance sheet". The balance sheet is like a building supported by two pillars. Increasing the equity pillar will improve finance strength. Reducing reliance on the liabilities pillar decreases financial risk.
Agencies would certainly prefer to work with an SME having a lower financial risk profile, all things else being equal.
Next, examine the Income Statement, also called the Profit or Loss Statement. If the business suffered from losses at least two out of three years, it would be worrisome. If a business is unable to turn in a profit, it is not running a sustainable operation.
Review the expenses and determine which one to cut. Take each expense line and divide that by revenue. Compute the answer as a percentage. Start with the largest percentage and determine what can be reduced. Then work downward to the next largest percentage and repeat.
It would be important to keep a healthy track record of profitable operations.
Cash is liquidity. Without liquidity, you would not be able to pay bills no matter how profitable your business might be. Your employees will leave you and your vendors will not supply you. Without products and employees to sell them, how is it possible to generate revenue to create profits?
Go to the Cash Flow Statement and look for "Cash flow from operating activities". If this is negative, it might explain why you are having difficulties with cash flow. You might need to clear out your old inventories for cash and go after your customers for payment with greater vigour.
You can bet that agencies would be judging you based on how sustainable your cash flow is.
Those are three ways on how you can improve your financial profile to help your business make it through the financial screeners used by agencies. As you learn more about how to tell the complete financial story from your numbers, you would be in a better position to improve them and in the process enhance the sustainability of your business.
The improved financial picture would make your business attractive not just to agencies, but also to bankers, potential investors, and even a listing on the Stock Exchange of Singapore.
The views expressed in this column are the author's own and do not necessarily reflect this publication's view, and this article is not edited by Singapore Business Review. The author was not remunerated for this article.
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James Leong C. Foo is CEO and Chief Trainer of Visions.One Consulting Pte. Ltd. A chartered accountant and adjunct professor, he helps to improve financial acumen, profitability, and cash flow of businesses and individuals through his financial fluency workshops.