How mismanagement, rather than external factors, is often the root cause of business failures among South African companies.
When the storm clouds gather and financial difficulties loom, companies often point accusing fingers at external factors. This year, there has been a spate of well-known South African brands falling on hard times and blaming the economy or loadshedding or interest rates – yet it can’t be ignored that other companies have prepared for these likelihoods and survived.
Frank Knight, CEO of credit management services company Debtsource, insists that beneath this blame game lies a deeper truth: poor management can be the silent saboteur, quietly eroding a company’s foundation.
In fact, mismanagement plays the most significant role in business downfall. “For example, we are seeing businesses becoming more resilient and better navigating the challenging economic landscape in an environment of decreasing risk. We have noted a decrease in delinquency ratios over the past four months, on the back of an improving economy. If interest rates decrease later in the year, I expect delinquency rates will improve further.”
He says that “positivity is in the air”, evidenced by South Africa having reclaimed its position as the biggest economy on the African continent, surpassing Nigeria and Egypt. “Business has expressed cautious optimism about the new government, sparking a general sense of hope among business owners. The power-sharing deals look solid, and while challenges remain, economic and political improvements are on the horizon, potentially leading to lower interest rates and better business conditions.”
Interestingly, he points to an increase in liquidation statistics from previous years, pointing out that this is a lag indicator. “It is indicative of poor management, which ought to have been focused on managing cash flow, reducing debt levels and proper debt management by avoiding high-interest rate lenders some of which charge as much as 5% a month. It’s essential for businesses to seek better funding options and avoid falling into the trap of high-interest loans.
“Bluntly, the test of strategy is profit. If you’re not making a profit, your strategy is ineffective. Certainly, factors such as high interest rates and loadshedding can weaken companies – but the problems pre-existed and these factors serve to draw them into a dwindling spiral rather than being the cause of troubles,” says Knight.
For businesses heavily dependent on external loans, the interest rate makes a big impact. Every time the interest rate goes up, even by 1% or half a percent, it means a significant increase in the funding required just to keep up with the repayments.
In response, businesses looking to improve their financial position must urgently review their debt levels relative to the size of the business and the overall cost. A general rule of thumb for current asset ratios is two-to-one between current assets to liabilities.
“The first management misstep we often see is the misuse of current cash reserves for long-term projects. This practice strains liquidity by tying up short-term funds in assets that require long-term financing. It’s a risky move because short-term lenders might suddenly demand payment before the long-term project yields returns.
“Secondly, smaller businesses sometimes opt for high-interest loans or invoice discounting to meet immediate cash flow needs. While accessible and sometimes necessary, these financing methods come at a steep cost.
“Another critical issue is the mismanagement of debtors. Companies frequently overlook the true cost of delayed payments from debtors. Every month a debtor delays payment translates into additional costs, impacting profitability significantly. Proper debtor management involves not only collecting payments promptly, but also vetting potential clients, setting appropriate credit terms, and possibly insuring against bad debts,” adds Knight.
He offers three basic tips (among others) to avoid debt mismanagement:
- Manage debt levels wisely: Go and really look at where your debts are within the business and work hard to reduce those debts.
- Focus on profitability over EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA) is a strategy famously critiqued by Warren Buffett because EBITDA might show profitability by excluding interest payments, thereby masking the true financial health of a company. Rather focus on profitability after all expenses, including interest payments, are accounted for as this approach provides a more accurate assessment of a company’s financial viability.
- Safeguard cash flow: “I advise businesses to meticulously monitor and protect their cash reserves. No business goes under when they’ve got cash in the bank. Maintaining a healthy ratio between current assets and liabilities is crucial, ensuring that businesses can meet short-term obligations and seize opportunities without jeopardising financial stability.”
Financing options exist that inject liquidity into struggling businesses without requiring additional collateral. A company’s liquidity hinges largely on the quality of its debtors. By optimising credit agreements, monitoring payment behaviours, and employing a recovery service, companies can ensure that cash flow remains healthy.
“These strategies not only mitigate financial risks, but also pave the way for sustainable growth and profitability. By aligning financial practices with prudent management principles, businesses can navigate economic uncertainties more effectively and thrive in the long term,” says Knight.
