The ebb and (cash) flow

Whether we would like to believe it or not, the fact of the matter is that the South African economy is starting to show signs of overheating.  As the saying goes, "the writing is on the wall". Now, without sounding like the proverbial prophet of doom, consider a few of the most recent signs

Property prices have sky rocketed beyond human belief but have started levelling off, if not declining somewhat; the JSE has reached all time highs and the pundits say that there must be a correction soon enough; imported inflation (primarily through oil) has shocked the nation at the petrol pumps; food prices have begun an inevitable climb; the 'season' for wage negotiations has got off to a distinctly rocky start with the largest employer (government) being the first to fall victim; rampant credit splurging has been the 'order of the day'; interest rates have seemingly begun an upward movement; CPIX  has exceeded targeted levels and legislation governing credit granting has come into effect.

So where does this lead us? - to the inevitable conclusion that the economy is sitting on a knife edge.  But what about the lead up to the World Cup 2010, you ask. Admittedly, government infrastructural spend is going to boost the economy, but bear in mind that this will only benefit certain sectors of the economy: building and construction; iron and steel; electrical and engineering are likely to be the sectors most positively influenced, whilst spare a thought for many others that are likely to be adversely affected in the coming months and years.

Cash flow is not unlike the ebb and flow of the tides.. it comes in and it goes out. For the tides however, it is guaranteed that the ebb is immediately followed by the flow. Management of cash flow, therefore, becomes crucial to the success of a company when the economy starts to cool somewhat. Unfortunately for many companies, realisation of this aspect comes too late. Why should this be?  Well, the immediate response is to try and boost sales, invariably by offering discounts.  Bad move - cutting margins should be a last ditch effort to improve cash flow.

Serious investigation should be undertaken into the factors which affect the 'ebb': management expenses; start with salaries and do an unemotional cost benefit analysis. Are there under-performers in the organisation literally leeching their existence?

Assess the use of 'consultants' and decide what could be brought back in-house.  Take a hard look at those items which could be considered luxury or unnecessary purchases.  Walk out into the parking area and take stock of the vehicles the company is paying for. Are they used productively?

Then have a look at the vehicles being driven by directors and officers that are being funded by the company.  If there is any vehicle which could be considered a luxury car, reassess the cost associated with keeping it. Is it a dire necessity or is it a status symbol.  You decide.

If the company is paying for bonds over directors' personal assets: homes, holiday homes, etc, make an honest judgement call and face up to the reality that servicing this debt could have a detrimental impact on profitability. Just think about Fidentia for a second.  Factor in the effects of the interest rate movements as well as imported inflation via the petrol pump and the picture starts to look a little bleak.  These are the lifestyle issues that sometimes are the hardest for directors to get to grips with when being forced to cut costs.

Then there is the matter of one of the biggest assets many companies have. their debtors book, so often overlooked as an asset.  When times are good, sales boom and debtors pay. Well, that is the theory anyway. What inevitably happens during the good times is the average collection period tends to move out almost imperceptibly first by a few days, then weeks and before you know it, your debtors book has gone from 36 days to 80 days. To get it back in line is now almost impossible, because your debtors are experiencing the self same problem. The proverbial horse has already bolted.  How now do you explain to your bank manager that the security of your debtors book that you so readily signed over as collateral has just lost a portion of its realisable worth?

In the good times, the bank will invariably assist you by advancing every cent you ask for and allowing leeway here and there, but be careful of how quickly the demeanour changes when the going gets tough, but dont be too quick to blame the bank for your folly. What other securities did directors sign over without a second thought during the 'good times'?  So what else is there to do when your debtors start playing hard ball?  It may already be too late to fix the existing situation in the example described above but, all too often, taking action to prevent bad debt is usually spurred on only once the pawpaw hits the fan.

The King II report makes a clear and unambiguous call to directors to ensure that all risk elements are scrupulously considered. Quoting directly from Mr 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 adverse liquidity is reckless, then the Companies Act intervenes and makes the directors liable for all the debts of the company."

The simplest solution to guard against debtor defaults or bad debt is to insure your debtors against the risk of non-payment. Let me draw an analogy; most companies would never allow a vehicle they owned to be driven on South African roads without being fully comprehensively insured; fact! But why so? The risk associated with a number of potential maladies that could arise when the vehicle is on the road is such that there is a very good chance that during its tenure on the road, it will be involved in one or more accidents or will be stolen. It is the inevitability of the matter. This scenario holds true for your company debtors as well. Sooner rather than later, one or more debtors is going to default on payment; it is that certain. What you decide to do now to prevent those losses from impacting adversely on your company's cash flow will set your company apart; fact! Insurance against losses won't prevent the loss from occurring, but does make bearing the loss just that much easier.