Maybe it’s not just a loan you need, but some tough love too

There are 10 million people employed in small businesses in South Africa, but that figure contracted 14% in the immediate aftermath of the Covid lockdowns.

With 11% fewer small and micro businesses by the third quarter of 2020, the fear is that some of this damage is permanent.

But some of that damage is self-inflicted, explains Michael du Plooy, chief operating officer at SME specialist lender Preference Capital.

“There’s no question that most small businesses were subjected to a horrible economic contraction that was not of their making, but in the many cases that we have reviewed, the situation was exacerbated by some poor management decisions,” says Du Plooy. “We have learned from experience that it’s not always just funding that a small business needs when it runs into trouble, but some tough love too. Management need a sounding board to make sure the decisions they make are rational and will result in the business not only surviving, but prospering over the longer term.”

It’s a point of satisfaction for Preference Capital that its clients have a higher survival rate than the average. “We’re quite a conservative lender in our subsidiary, Cash Flow Capital, and we’re unapologetic about that. We want to make sure you have a business that can repay debt and is in a stronger position as a result of our intervention.

“There’s no doubt that once you’re accepted as a Cash Flow Capital client, your prospects are good. We’re not looking to build up a loan book to please the shareholders. We want to make sure it is profitable.”

The company brings an eclectic mix of skills to the problems typically facing small businesses, including former bankers, accountants, compliance specialists, risk and data analysis specialists, and those, like Du Plooy, with a background in investment analysis.

“We had to develop our own methodology for analysing smaller companies. We don’t look at companies the same way a bank would, for example. We look far beyond the usual banking obsession with collateral. We’ll go into the nuts and bolts of the business, including its culture, to see how we can help in times of need.

“The question we are always asking ourselves is: the people we declined for loans, did we decline them correctly, and the people we approved, did you approve them for the right amount?”

We asked Du Plooy for his take on some common cash flow problems facing small businesses.

Why is cash flow management so important, and what are some of the more common causes of cash flow shortages?

One common cause of cash flow shortages is the owner-manager who makes unilateral decisions without anyone challenging him. So he might end up over-ordering stock on the assumption that this is the best way to boost sales. That, of course, assumes the business doesn’t have sales because it does not have stock. They don’t realise that stock is cash locked up.

Debtor management is horrendous in most businesses. Every business is a collections business, and if you neglect that you are going to quickly end up in trouble. We’re seeing a lot of neglect around debtors, with 120-day debtors mounting up, and the business owners don’t want to write this off, because that must then be expensed on the income statement. So one of the disturbing trends we are seeing is accounts payables building up, while outstanding debtors is likewise growing, and that means less cash in the business. In our experience expensive debt, used over and over, eventually becomes a permanent part of your capital structure. That’s why at Preference Capital we have the means to move clients to cheaper products as our relationship with the client progresses.

We’ve also seen margins dropping during Covid. Some business owners used Covid to restructure, cutting back on expenses such as labour and rent. However, our labour laws make it difficult for any business to restructure significantly because your two biggest expenses are wages and rent. Landlords have traditionally bullied small business owners by demanding turnover clauses in their rental agreements, but now – with commercial properties struggling for tenants – it is the business owner that suddenly has some negotiating power.

What should some owners consider when trying to manage their cash flow?

If you’re in a growth phase, you will need capital. You must choose whether to fund your growth through equity or debt. Equity is more expensive longer term.

If the business is in financial trouble, should it be looking for a loan? The short answer is no, which may seem odd for us to say as that is our business, but what the business needs is to look at cheaper options that are available. For example, if the business owners has an unbonded property, then bond that property and raise finance against that. That’s cheaper and more flexible than most other forms of finance.

Bear in mind that virtually all businesses got to where they are with debt. However, you must be careful with debt as it can become entrenched in your capital structure, and you want to avoid that.

Why is it so difficult to manage cash flow effectively?

It’s easy to manage cash flow, but business owners get into bad financial habits, usually spending too much, ignoring issues like cash flow, and failing to build up a war chest. What if we have another July 2021 riot? Entrepreneurs are typically biased towards the positive side, when a more conservative approach might be warranted. In SA, we build the biggest restaurants in the world. If a small restaurant is doing well, it might be an idea to replicate another small restaurant, rather than plan for a giant, 200-seater that you cannot fill when times get tough. People want to make money fast, and that can lead them to make irrational decisions.

What is the current financial environment in SA post Covid lockdown and how can this affect the management of cash flow in a business?

The current environment for SMEs is fragile, but there are opportunities out there. Cash is king at the moment, but you need to manage it well. Those that manage their cash well, who keep a tight rein on debtors, keep spending under control and build up a war chest, could do very well over the next few years. If we can educate people in using cash properly, then we see massive opportunities. I think it’s important for business owners that survived the last two years to pat themselves on the back. I am sure we all learned some valuable lessons about cash flow during this period. Now it’s important not to slip back into bad habits and to start planning for the longer term, for the next five to 10 years.

Brought to you by Preference Capital.

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