WHY CASH FLOW IS KING

DRIVE FOR show, putt for dough. This advice suggests golfers who focus too much on the kudos they receive for hitting furthest – usually at the price of accuracy – are often beaten by golfers who are sharper around the green with the less glamorous putter.  

It’s not unlike the fixation that some principals and agents have with listing and sale numbers – the top line numbers – when, in fact, it’s the less headline-grabbing cash flow figures that really drive an agency.

Jason Roach, national leader, real estate and professional services at Westpac, says cash flow is critical to an agency’s survival.

“Cash flow is oxygen, it’s what keeps the business afloat,” he says. “The deal’s not done until the money hits the tin. Your company will die very quickly otherwise.”

According to Shaun Bassett, head of residential real estate segment, Macquarie Relationship Banking, cash flow “is the life blood of any business”.

“The ability to service and repay debt, meet commitments to creditors, pay wages and meet ATO obligations is dictated by cash flow – both volume and timing of the same,” he says.

“A common misconception by principals is that the level of gearing their agency can support is solely a question of the value of their assets (primarily rent roll). In reality, whilst the value of the asset to secure the debt is a key factor, it ranks behind the ability to service and or repay the debt and accordingly, cash flow is vital not only to the present but also to the future growth aspirations of a real estate agency.”

COMMON ISSUES

Problems with cash flow often stem from a lack of business acumen or experience.

“Decisions can sometimes be made on the success of the revenue line without considering the timing differences with collection and the costs that need to be paid for the key suppliers,” says Ian Farquhar, industry solutions executive, industry solutions at NAB Business.

“Unless cash flow is closely managed there is a danger that the timing differences with the sales commissions resulting from settlements are not considered, particularly if there is a delayed settlement.”

Stan Crook, director of Queensland Residential Property Services (QRPS), agrees.“Many principals who own a small agency are primarily sales-orientated,” he says.

“Most are highly successful in that role and, generally speaking, are the main source of writing deals. Unfortunately, they don’t keep an eye on the business.”

Andrew James, director of hockingstuart Armadale in Melbourne, agrees that principals can struggle with managing a business, although his group helps with this.

“We’re able to speak to other [hockingstuart] franchise owners about how their businesses are run,” he says, “and not only [about] cash flow but a wide variety of areas.”

Mr Bassett says cash flow issues typically arise in businesses with a working capital requirement and those exposed to unpredictable or seasonal market conditions.

“With advertising budget/spend in a typical real estate agency representing a larger spend than any other single expense line outside of salespersons’ commissions, and only 33 per cent – as per our

2012 Residential Real Estate Benchmarking Survey – collecting the costs upfront from vendors, a significant working capital requirement exists in a lot of agencies,” he says.

“With longer days on market (74 versus 67 in 2009), increased incidences of sales falling over and without being highly systemised and disciplined around collecting advertising, the working capital requirement can easily become exacerbated.”
Vendor-paid advertising (VPA) is a key component of the cash flow equation, according to Mr Roach. “One group I know tells its members that, if they want to carry VPA, the individual agent has to pay for it,” he says. “This keeps the individual agents responsible for VPA, and cash flow.”

Mr Bassett says factors outside of the business can also have an impact. “The principal drawing out a level of cash to meet personal/lifestyle commitments … places a strain on what is available to meet internal commitments [and] is somewhat common.”

Mr Crook adds that some principals see collected GST as income and use it for those purposes. “Then, when they need to pay GST they find they have insufficient funds in the bank,” he says.

TAKING OWNERSHIP

Principals need to take responsibility for managing their agency’s cash flow although there is certainly a role here for an independent financial professional.

“Ultimately, the responsibility for the cash flow position of a business is that of the principal/owners,” says Mr Bassett. “This isn’t to say, however, that they are necessarily the best qualified or placed to perform this function on a daily basis.

“The principal / business owner should have some kind of regular and independent system in place – independent of the individual managing on a day-to-day basis – for monitoring and keeping themselves abreast of their position.”

John Percudani, director of Perth-based Realmark, says most principals think in terms of monthly financial cycles as opposed to having a broader ‘helicopter view’ centred on quarterly, yearly and multi-year targets.

“You’ve got to know what are the [financial] outcomes and the trends. Year on year on year, [you’ve got to know your business’] patterns,” Mr Percudani says. “We’re sitting with them [our principals] constantly, generating 100-day plans.”

Principals within the Realmark network receive considerable business management support from head office, he continues.

The focus, however, is on ‘action numbers’ – targets that drive sustainable business. Some of this support includes using analytical templates, giving principals a relatively simple dashboard of numbers to follow.  

“We chunk the market down,” he says. “You need X percentage of the market, and this means X number of listings [as an example]. We give them simple formulas, and a one-page business plan that includes KPIs that they can monitor each week.”

Realmark also builds incentives for ‘rainmakers, the property managers, business development managers, sales agents and others who help to deliver business.

The targets aren’t necessarily top line-focused but can instead be directed towards goals that help the business become more efficient and effective.

“For example, in property management, it’s amazing how much leakage there is around ancillary fees, so a KPI bonus relative to the billing and collection of ancillary fees [has been established],” Mr Percudani says.

Mr James, along with co-director Andrew Summons, takes an active interest in several figures when assessing their business’ performance. These numbers are produced by an external accountant, which allows them to focus on selling properties and driving revenue to the business. These numbers include, among others, break-even points, average cost of sales and average commissions over the past 10 years.

BEST PRACTICE

So, what is best practice when it comes to managing cash flow?

According to Mr Roach, agencies should always aim to have between three to four months of working capital available. This might be a combination of bank debt and
self-generated cash flow.

Targets can be helpful, although according to Mr Bassett, it’s hard to give a specific set of goals to all principals.

“Understanding the business model and cash flow position means having a good understanding of the fixed cost coverage ratio – the level of fixed costs covered by property management commissions – and the break-even [position for the business] – the number of sales required per month, even per salesperson,” he says.

According to Mr Roach, while most businesses aim to have their property management operation account for

100 per cent of the overall business’ fixed costs, in his experience most agencies’ property management divisions took care of between 50 and 60 per cent of those costs.

Georg Chmiel, CEO at LJ Hooker, says his group likes to see its offices aim for property management income to cover 100 per cent of their fixed expenses.

“A good rent roll should cover your fixed cost base in an agency office, and that’s what we’re educating our agents around,” he says.

Most LJ Hooker offices perform well, with some more than covering their fixed costs.

“This is a fantastic position to be in,” he says, “and that’s just the direct impact of the rent roll. The indirect impact is the sales the rent roll generates. Approximately 10 per cent of the properties in a rent roll will sell within a year.”

The message appears to be getting through to more principals, with the Macquarie Relationship Banking 2012 Residential Real Estate Benchmarking Report finding that property management revenue now accounts for a greater share of an agency’s fixed expenses.

“In considering fixed costs covered by recurring property management commissions, the industry average in 2009 was 48 per cent and has risen to 55 per cent in 2012,” the report said.

Mr Bassett adds that purchasing a rent roll can be an immediate cash flow positive transaction for an agency.

That is, “the revenue associated with the acquisition – commissions, letting fees, other ancillary fees – outweighs the cost associated (additional PM staff, interest on debt, operating expenditure costs) and can aid an agency reach a critical target rent roll size (i.e. 300, 500, 1,000 properties under management) in a quicker manner than organic growth.”

Andrew James is one principal who is reaping the rewards of a rent roll. His office has around 650 properties under management, something that keeps his cash flow ticking over.

“That’s an important part of the business, and helps cash flow during that quieter time of the year,” he says.

Mr Farquhar adds one caveat: “Cash flow via the recurring revenue streams is assuming the majority of properties under management are rented out,” he cautions.

Payment options are another important consideration in the cash flow equation, particularly in relation to property management. “Provide your rental customers a variety of simple payment methods to make it easy for them to pay on time,” he says. “Offering a choice of payment options, whether they be direct debit, EFTPOS, BPAY, over the telephone or the ability for your customers to make payments online, may help you collect funds faster.

“Implement a payment solution with automated reconciliation in order to maximise your property manager’s time working on things that matter.

“Do regular audits of the rent roll paperwork to ensure that if you are selling your rent roll at a future date, you have confidence that there will be no surprises on the valuation, such as the number of properties under management not matching what the reports are showing.”

Mr Bassett adds that while property management is important, it’s critical to have a balance with the sales side of the business.

“On the revenue side,” he says, “most successful business models within real estate have a good balance between the contracted recurring revenue – for example, property management revenue – and the more unpredictable yet potentially larger revenue upside provided by sales.”

SUCCESSFUL STRATEGIES

Another way in which Mr James seeks to ensure steady cash flow involves using a law that is unique to Victorians: Section 27 of the Sale of Land Act 1962. This allows vendors to request the early release of the deposit, which in turn means the agent gets paid more quickly.

While Mr James was unable to say how often this occurred in his business – purchasers can, in some instances, refuse to allow the deposit to be released prior to settlement – it was something they encouraged with a view to improving their cash flow.

Enzo Raimondo, CEO at the Real Estate Institute of Victoria (REIV), says this may not always work out for the agent, however.

“Whilst this can sound simple it can also take some time,” he says.

“If you have a short settlement period it may be that it is no quicker than waiting for the settlement date.”

In addition, to make the best of the time during the quieter period between mid-December and late January, Mr James pre-plans to have 20 auctions booked for February, ensuring they’re ready to hit the ground running when they return from the holidays.

“You’re starting on a positive note, and we’ve also got business coming in,” he says.

One important strategy when it comes to cash flow, according to Mr Percudani, is diversification. “The more legs you have, the more stable the business is,” he says.

Realmark, which incorporates strata management, property management and commercial and residential property businesses, aims for a varied offering to help smooth out its revenue streams.

Realmark has eight offices and so, from a group perspective, diversification also includes having a geographical spread so a variety of different markets are covered, and a property spread, which includes having listings at different price points.

“You don’t want to make your business vulnerable to one market,” Mr Percudani says.

He also believes it’s important to challenge entrenched perceptions about when sales are ‘meant to happen’.

“We noticed that in our commercial division [in relation to quieter periods], but it was because we were telling people that this was a good time or a bad time to sell,” he says.

“I don’t go along with the adage that spring is a great time to sell. Serious buyers are always in the marketplace.

Keeping your stock moving is another simple way to maintain steady cash flow, according to Mr Roach, and to do this, principals should “ensure listings are priced correctly from day one”.

He adds that if you are going to be short of cash, it’s better to face up to this fact early, particularly if the agency is looking to a lender to help finance them through a lean patch.

“Early intervention is best,” he advises. “Principals should have a strong relationship with their bank, including regular meetings so your bank has a thorough understanding of your current and future state.

“All things being equal, this should give agencies a better chance of getting funding. If we [lenders] have confidence that the principals running the business are proactive and understand what the needs of the business are, it makes it easier for lenders to have a really coherent understanding of what they may need.”

Mr Farquhar agrees. “If there is a tight cash position and the agency can foresee having difficulties operating within their banking arrangements,” he says, “it is best to let their bank manager know as soon as possible.”

SMALL FIRMS STRUGGLING TO PAY BILLS

The number of Australian businesses paying their bills on time fell during the June quarter, as businesses struggle with reduced cash flow.

According to the latest Dun & Bradstreet Trade Payments Analysis - examining the ability of firms to pay their bills, and pay them on time - the number of payments falling within the standard 30-day term fell 16.5 per cent quarter-on-quarter.

Further underscoring the deteriorating conditions faced by businesses is the performance of small businesses, which recorded the biggest deterioration in payment terms of 2.2 days. Businesses with between one and five employees are now operating under an average term closer to that of larger firms, at 53.2 days.

The national average is 53.6 days. In addition, two-thirds (62 per cent) of all trade payments were late during the second quarter. The number of severely delinquent payments (90+ days overdue) also rose noticeably during the last 12 months - up 13 per cent since the June quarter last year.

According to Dun & Bradstreet director, Adam Siddique, cash flow issues within the small business sector will have a significant knock-on effect to the rest of the economy.

“Small business payment terms now more closely resemble those of a large corporation, however small operations are less equipped to manage for cash flow issues, particularly if they are waiting more than two months to be paid for goods and services,” he said.