What most companies fail to note when considering the impact of bad debt is that the loss is far greater than the outstanding revenue. It is the totality of all phases of the relationship from first call and delivery of the service to invoicing and pursuing the debt.
To quote that remarkable South African, Mervyn King SC, “The question of the duty of directors in regard to credit risk is evolving. Directors’ duties are owed to the company and the company alone. But when the company runs into liquidity problems the question is being asked whether the duty of directors starts to be owed to that important stakeholder, the creditor? If the continued conduct of the business in the face of an adverse liquidity situation is reckless, then the Companies Act intervenes and makes the director liable for all the debts of the company.”
With this evolution, the need to ensure that a company’s debtors settle their accounts timeously becomes a priority. The economic boom might have led many suppliers to permit payments outside normal terms, but with the apparent cooling of the economy coupled with the increasing interest rate regime, getting debtors back to terms might now be an almost impossible task.
Serious thought should be given to imposing stricter terms and a far more stringent debtors’ collection procedure. Companies that have already insured their debtors with Credit Guarantee undoubtedly have an upper hand. Many debtors lead their creditors a merry song and dance, but with the backing of the biggest debtors insurer on the African continent, they are less inclined to do so.
While the credit insurance policy provides indemnification of insured losses that may occur and is a vital safety net, the greatest benefit is gained from the credit investigation process that is conducted in respect of each debtor being supplied. The resources that Credit Guarantee puts into this aspect are enormous compared to what any company’s own credit department is usually capable of. Multiple sources of information, both external and internal, are employed to make better reasoned judgement calls when accepting risk on behalf of clients. With the great difficulty experienced today in gathering information on debtor companies, it makes sense to ‘outsource’ this aspect to an expert in the field.
Liquidations On the Rise
Total liquidations in the third quarter of 2007 of 1166 are 70% higher than in the second quarter and 40% higher than in the third quarter of 2006. Note that the public sector strike has affected the veracity of these figures. However, the telling figure is that company closures are 10,6% higher in the first nine months of 2007 compared to the same period in 2006. Interestingly, CC liquidations were 14,5% lower in the first nine months of the year while company closures escalated 36,5% over the same period. Personal sequestrations in the first eight months of 2007 are 19,8% lower than the comparative period in 2006.
Civil judgement data appears to be suffering from the same civil sector strike malady. In the first eight months of the year, debt defaults against businesses are reported as being 29,4% lower in value terms and 34,4% lower in number. For private individuals, the reported results are 0,4% higher and 8,3% lower respectively.
Credit Insurance Policies
Once a prospect company takes out a credit insurance policy, a ‘Credit Limit Application’ needs to be submitted in respect of each debtor company. Credit Guarantee thoroughly investigates each and every ‘risk’, locally and in export markets and if approved, issues a “Credit Limit” individually. Should any debtor renege on payment, a claim is lodged. Where applicable, legal action or ‘recovery’ procedures are initiated. An indemnity of up to 90% is paid depending on the type of loss sustained, reducing the effect on clients’ cash flows. Premiums are charged in a variety of ways depending on the type of insurance policy and on the needs of the client. This can be a fixed amount debit order, according to balances owing or based on monthly turnover. The cost can vary accordingly from 0,5% to 1%.
Insuring the Debtors Book
There are so many very high profile companies that are ‘recently departed’ in a manner of speaking…Tigon, ATS Tiger Wheel, Master Bond, Fidentia, Thiele Design, Shoe Crazy / Mirelli, Printability and not too long ago, Retail Apparel Group (RAG) among many, many more. Importantly, there are many creditors to these companies that may also have failed had it not been for their forethought and vision when it came to making the decision to insure their debtors books.
Insuring the Most Valuable Asset
Like any and all insurance policies, you hope never to need them and having to claim means that some or other malady has struck, usually with debilitating consequences. For many companies, it may be very likely that their ‘debtors book’ is the single biggest asset by value and yet may be the very last being considered for insurance… why? Non-payment of money owing to your company may be its very death knell – now that’s a sobering thought.
Financial Metrics In The Business World – Keeping An Eye On KPI’s
The results and findings after each analysis, using the relevant metrics, then create a premise for strategising and executing specific tactics needed to improve, uplift, as well as highlight where increased attention should be directed.
Monitoring sustainability and the condition of a company’s business model plays a key role in the overall performance and success of an organisation. If these are given the required attention, it would enable easy identification and corrective protocol to eliminate or curb potential problems or detriments.
One of the accounting metrics serving this functionality are Key Performance Indicators, better known as KPI’s. Metaphorically speaking, you could say that just as an Electrocardiogram would monitor your heart, so to would specific KPI’s measure up the health and activity of particular areas of a business. This ultimately leads to a fine-tuned route to achieve financial success.
The two main relative KPI’s would be Financial and Non-Financial. The former would assist in portraying a full view landscape which proves critical when it comes to competitive advantage. These provide quantifiable accounting metrics that are simple to analyse, hence easy to act upon.
An example would be the Debt to Equity Ratio – a ratio calculated by looking at a business’s total liabilities in contrast to the shareholders’ equity. This indicator is vital, helping to keep focus on the financial accountability.
The latter, being Non-Financial KPI’s, are measures not quantifiable in monetary units. Typical non-financial KPI’s would range from product and service quality to human resource management. Also an essential avenue to keep a consistent tab on in order to maintain an ardent image.
A critical element in forming these metrics would be ascertaining what is important to the organisation at hand. The development of KPI’s should be part of an overall strategic management process that connects the mission, vision and strategy of a business. Keeping in mind the goals, both in the long and short term.
Aside from the metrics relating to KPI’s, the most crucial aspect in financial management would be accuracy. Processes that aren’t efficiently controlled along with inaccurate data input, will inevitably have an adverse effect on the business and also leave a window open for measurement inversion. Imagine executing massive plans based on incorrect results and information. This could jeopardise any business severely. Furthermore, the most advanced metric structure proves futile if the information used to ascertain a desired result lacks accuracy. Hence, any enterprise must ensure that there are always effective controls in place with heightened scrutiny over accuracy levels. Regular checking procedures and reconciliations at set intervals need to be structured to maintain this.
Small Business Has A Critical Role To Play In The Economy – But Entrepreneurs Need Better Financial Skills
While government is stepping up to support small business more than ever before, the sector will not thrive unless entrepreneurs are also equipped with the financial tools to optimise their organisations – UCT Associate Professor Mark Graham.
The role of small business in promoting growth and development has shot to the top of the agenda this year with both President Ramaphosa in his inaugural SONA and Minister Malusi Gigaba in his budget speech highlighting the critical role of this sector of the economy.
Globally, SMMEs are recognised as one of the key drivers of economic growth and job creation – and it is clear that the small business sector has led the world out of several global recessions – but in South Africa, the sector is under-performing.
Entrepreneurs need help to become sustainable
Recent data from the Global Entrepreneurship Monitor shows that South African entrepreneurship lags behind that in similar economies. And for every 1.5 people who were engaged in early-stage entrepreneurial activity in SA in 2016, one was exiting a business.
According to Mark Graham Associate Professor in Accounting at the University of Cape Town, typical reasons for business failure include: insufficient start-up funding, incorrect pricing for products or services, growing too quickly or prematurely, and inadequate cash flow.
“We need entrepreneurs to run their businesses successfully so that they can be sustainable,” he says. “Most of these issues can be addressed through a proper understanding of financial and accounting principles and concepts to help entrepreneurs run their businesses better.”
A growing understanding of financial principles
Graham, who runs the Finance for Non-Financial Managers programme at the UCT Graduate School of Business (GSB), emphasises that finance and accounting terms are really just a language that uses numbers to tell a story about a business.
“If you understand the fundamentals of financial principles you will be able to analyse what is happening in any organisation,” says Graham.
“Concepts like profit and cash flow are basic to business. However, people are often surprised to find that while a business can be extremely profitable, there may be a cash flow problem that will soon bring it to its knees.
Most people don’t know the basics of financial reports, what the right capital structure (i.e. the mix of debt and equity) might be. By getting to grips with concepts like working capital management and cash flow vs profit, business owners and managers can give themselves the best chance of success.”
Financial literacy is key to entrepreneurial success
Jannie Rossouw, head of Sanlam’s Business Market, agrees that financial literacy is key to entrepreneurial success and has argued that it should be integrated into the school curriculum so that future business owners can understand critical concepts like the time value of money.
“It is imperative that SA starts to spend significant time and resources to address the need for access to quality education aimed at those who want to pursue entrepreneurship and business ownership. We shouldn’t only start teaching these skills at the tertiary level,” says Rossouw.
And it is not just entrepreneurs that would benefit from a better grasp of the basics of finances, says Graham. All businesses should invest in developing the financial skills of their people – especially those in managerial roles.
“It is important for everyone working in business to understand the basic language of business and demystify the jargon – which is one of the things that the course I run at the GSB seeks to do,” he says.
“Feedback from previous course participants shows that people really appreciate being able to see how the numbers are telling a story about the health – or lack thereof – of a business and that this helped them make better business choices.”
Financial tools are needed to optimise businesses
“Sustainable small businesses have big potential to make a significant contribution to the SA economy and put a dent in the unemployment figures. So when Gigaba said that by enabling new businesses with new ideas to emerge and thrive, ‘we are radically transforming patterns of production in the economy’ he is not wrong.
But unless serious steps are also taken to equip owners and managers with the financial tools to optimise their companies, we will find that despite more proactive government policies and funding, the small business sector will still not thrive.”
Build A Financial Model
Start-ups often struggle to develop a suitable financial model for their new businesses. Here are some of the most important financial modelling considerations.
All budding entrepreneurs spend long hours typing up a well versed strategy document for their new entity, as expected. However, very often there is insufficient time allocated to the crux of the business, the numbers.
Definition: Financial modelling is the process by which a firm constructs a financial representation of some, or all, aspects of its business.
For any new start-up entity the initial necessity for assessing potential returns on new investment or seeking external funding can be a daunting process. Whether you are soliciting funds from an institution, or a high net worth individual investor, the financial projections could make or break your deal.
Although you as the founder are naturally optimistic about the new venture, be mindful that most investors would rather see the worst case scenario. This allows the potential investor/banker to take a realistic view on the maximum potential losses, should the business fold in the first 12 – 24 months. As such, it is recommended to produce a low, middle and high road model, for a three to five year period.
Inputs and outputs
Most importantly, always keep in mind that your financial model is nothing more than certain inputs producing certain outputs. By designing the model correctly, a user should be able to change certain inputs to assess the impact of these changes on the related outputs (commonly referred to as a ‘what if analysis’ or ‘stress testing’ a model).
By way of a simple example, your sales revenue line for any specific month should be a function of the number of products sold, at a specific sales price.
For ease of use, both you and a potential investor should be able to adjust either of these variables in order to see how resilient the business model is, should your assumptions be incorrect.
Other basic recommendations when building your model:
- Create an assumption page, clearly defining any assumptions on which the model is built. By linking certain variables to the assumption page the model becomes robust and user-friendly.
- Be as transparent as possible, showing all formulae that lie behind calculations. This allows the user to easily follow logic through the model.
- Aim for simplicity and ease of understanding. Over-complicating a financial model with unnecessary worksheets can confuse and overload the reader.
- When inputting projected overheads, deal with each line item separately, without consolidating. This demonstrates detailed thinking, and allows discussion around each expense if necessary.
- The model should evolve with the business. You should be looking to check the assumptions made at the inception of the business, with the reality of what is achievable, after having the benefit of hindsight. By tweaking the numbers accordingly, the model becomes a more accurate prediction of the business in the future. This should be an ongoing process.
- Beware of attempting to use a generic template that may not apply to your business. Trying to customise these generic models could complicate a would-be simple model. Building your own bespoke model from scratch is the cleanest approach, even if assistance is necessary. This forces you to learn the intricacies of your model, which will hopefully stand you in good stead.
- Many books and websites recommend a myriad of options when it comes to building financial models. As a principle, lean towards the concept of simplicity, provided you are able to integrate your model into regular projected income statement, balance sheet and cash flow statements.