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Credit Guarantee
Sunday, July 1, 2007
Bulging book

Property prices have rocketed beyond belief; the JSE has reached all time highs and the pundits say there must be a correction soon enough.

It suggests, if nothing else, an increase in bad debts. Insurance for this is available from Credit Guarantee.
Inflation shocks through heavy fuel pump and food price increases have clobbered the economy, throwing government into confrontational wage negotiations and threatening the Reserve Bank’s resolve to control an overheating economy.
So where is this leading us? asks Credit Guarantee, which believes the economy is “sitting on a knife edge.”
Government spending on the infrastructure is going to boost the economy, but bear in mind this will only benefit certain sectors, such as building and construction; iron and steel; and electrical and engineering.
Management of cash flow becomes crucial to the resilience of a company if the economy starts to cool. Unfortunately for many the 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 that affect cash flow, especially management expenses. Start with salaries and do an unemotional cost benefit analysis. Are there under-performers in the organisation literally leeching the company dry?
Assess the use of ‘consultants’ and decide what could be brought back in-house. Take a hard look at those items that could be considered luxury or unnecessary purchases. Walk out into the parking area and take stock of the vehicles for which the company is paying. Are they used productively? Then have a look at the vehicles being driven by directors and officers, also funded by the company. If there is any vehicle that 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.
So how 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. And don’t 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’? And 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. It’s a service Credit Guarantee has specialised in for many years.

Copyright © Insurance Times and Investments® Vol:20.6 1st July, 2007
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