10 Feb 2020

Rising above short-term pressures for long-term sustainability

Marc Rosen

Head of business development

The energy crisis has resulted in businesses focusing more on short-term survival strategies than on long-term plans. What is needed to re-ignite growth is funding, which means a new approach to debt...

Receive Focus insights straight to your inbox

The World Bank recently cut South Africa’s economic growth forecast for 2020 to below 1%, a direct result of electricity supply concerns which have had a fundamental impact on the economy in a number of areas. 

None more blatant than retail activity which became subdued due to a loss of operating hours and sales as a result of load shedding, and this during peak trade, a period heavily relied on for annual turnover. Peak sales volumes were lost and cannot be regained.

Similarly, the impact of the electricity supply crisis on the manufacturing and production sectors is no less dramatic, where insufficient production cycles means unfavourable production volumes that are required to cover overheads, quickly leading to a loss-making scenario.

And of course, if one considers the impact on the mining sector, you need not look further than announcements from the significant producers in South Africa who have come out explaining the direct impact on their profitability as a result of lost mining hours due to load-shedding.

Consequently, there is no doubt that this lost revenue generation will ultimately lead to lost profitability for South African businesses and therefore lower tax collections by SARS. As a result, South African businesses, and our economy, now finds itself on the back foot.

 

The impact of uncertainty

For the South African GDP to grow, capital investment and investment into business is required. However, South African businesses are questioning their investments in capital expansion, especially at a time where the operating of these capital assets could be at the mercy of the electricity supply of Eskom. 

This reluctance is on the back of the required policies needed, at Government level, to entice investment and stimulate growth.

So, the question then is not how the World Bank forecast is going to impact business, but rather how business is going to be able to perform against a backdrop of uncertainty, and, more importantly, whether the deteriorating business environment can be slowed?

This has seemingly led to a change in the business psyche. Businesses now find themselves focused on the short-term realities instead of adequately planning for the longer-term, potentially running the risk of sacrificing sustainable long-term ideas in order to address these short-term pressures.

READ MORE: Brace yourself! Five predictions for Budget2020

Survival strategies for business

So, what strategies are needed for growth in this climate? We know that the impact of an uncertain economic environment has undoubtedly led to various pressures in the business cycle.

Take manufacturers for example, businesses find themselves sitting on inventory for elongated periods, due to longer conversion cycles as a result of reduced production hours.

Those businesses with perishable items are in an even more invidious position and may see a larger spike in impaired products unless they order on a much shorter cycle, more regularly.

Examining elongated payment terms and/or a more regular order cycle could be strategies to alleviate some of this pressure. The use of financing can also address this challenge, allowing a customer additional time to settle their creditors by changing the creditor from the product supplier into a financial trade partner. In doing so, the business can pay for their stock, after a longer period, accommodating the longer operating cycle required to manufacture and sell goods.

Further down the working capital cycle, we also know that businesses rely on the cash payments from their customers for goods sold. However, in this difficult economic environment, a business’ customers are often also under pressure and require additional time to pay.

This then automatically creates further cash flow pressure for the supplier, as they now have to wait longer for cash to be received – and we know that this is often the same cash that is relied on for their repurchase of stock.

Again, by examining how to raise funding, against the debtor (receivables), a business can bring forward the timing of actually receiving cash in bank, by allowing a financier to provide that funding, in advance, against those receivables, thereby releasing the cash tied up in their debtors book.

Lastly, businesses can also look to enter into lease agreements or other financing mechanisms, which will reduce the large upfront cost associated with purchasing capital assets outright. Financing against assets allows a business to purchase capital equipment, and repay for that asset, over a longer period in time, which alleviates the upfront cash drain on the business.

Is there a financial way out?

Yes, if South African businesses recognise that they need funding to kick-start and reignite growth. Which means that their view on debt must change.

While previously seen as a negative aspect, if a business correctly identifies where its money is tied up (be it in its stock, debtors, capital assets) and finds financing options to unlock that invested capital, it can benefit tremendously.

In fact, managed debt can be one of the most cost-effective forms of financing available to a growing business. If a company is stable and well-established and has both assets to borrow against and the cash flow to service the loans, they can then utilise this form of debt strategically.

It is critical for businesses to understand the use of a debt instrument relative to an equity instrument.

Debt instruments generally are most beneficial if they match the working capital cycle of a business and can provide cash to a business at the right time.

Core funding options to be considered include, trade finance, receivables finance and asset finance. If a business unlocks cash tied up in its stock, debtors and assets correctly, this can often allow a business to trade better and make better decisions, which in turn can generate increased shareholder value.

However, it would be incorrect to see debt as the source of cash used to stop losses. This means that it is only sustainable businesses which are best placed to use debt to assist with growth – as loss-making businesses often require a different financial instrument in the form of equity to allow for business continuity.

While this can be a lot for businesses to wrap their head around, they need to know it is not how the World Bank forecast is going to impact business, but rather how business is going to be able to perform against a backdrop of uncertainty.

Businesses that allow for the deployment of their cash resources, at the optimal points in their operating cycle, can generate increased turnover levels and in turn greater profitability. Ultimately, hopefully assisting in bucking the current trend and finding a means to grow and in turn, contribute to increased GDP for South Africa.

 

This article was originally published in City Press.