Working Capital Management: Why many SMEs fails to honour a debt facility from Financial Institutions

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Introduction

In response to several questions received on my previous articles relating to SMEs and Investment supports. It has to be noted most of my writings relating to Small and Medium Scale Enterprise investment with a focus on the continent of Africa, largely West Africa region is born out of the direct and indirect experience beyond academic settings to industrial engagement in other to appreciate the conditional environment which the business exists as well as the operational character of the business within their growth circle. And with ultimate carefulness analyze the intrinsic problems of the businesses, which has a great impact to kill the operating vision of the business faster than the extrinsic effect of the environment.

There are numerous justified writings, narrating how SMEs on the soil of Africa mostly struggle to past their 5th year of existence with an estimate of 90% of the start-up businesses in this category, with most of the blames shifted to extrinsic factors of the environment as numerous peer-reviewed publications on SMEs in Africa submit, with 89% of such papers focusing the blame on lack of capital and poor enabling environment for the businesses to thrive, yet ignore to discuss collapsing SMEs with easy access to capital under the same circumstance. However, I do argue that, after the attainment of independence by member States of the continent of Africa, there has not been any evidence of a completely hostile free independent domestic private sector to proactively champion and revolutionized its economic development. Yet certain determined individual businesses have defied all odds and progress through the economic market from the level of small scale enterprises to transition beyond a medium-scale enterprise into large operating International companies.

It is scholarly argued and currently as an accepted notion that SMEs’ performance is the engine of economic growth yet the evidential data of the industrial economy of Africa interprets contrarily to this popularly held view. And the reason has been simple, from the observational performance index of the SMEs ecosystem of Africa, it easy to conclude most of the operating SMEs in member countries are statistically recognized for data analysis due to their legal registration status with States Institution not by their significant effect in the contribution to economic growth, instead, their operating performance is meant to satisfy the subsistence desire of its promoters. As a result most of its promoters never pay key attention to the required ingredient to uphold the resilience content of the business in a hostile economic climate for a longer period of time. And one of such key ingredient to discuss in this article, which is the leading cause of collapses of many promising ventures holding quality vision within their 3rd to 5th year of existence and sometimes fail to honour their debt obligation with financial institutions is ‘Cash management’.

Working Capital Management

It is observed, in certain precarious situations, it becomes very difficult for the administrative management of Financial Institutions to decisively blame the credit-management team for a poor work done when a business has passed through the rigorous credit-risk analysis to obtain credit facility from the Bank yet failing to honour its debt obligation. And the reason is also simple, for the mere fact, a business passes through pre-criteria credit assessment test as credible enough to honour it debt facility never implies the probability of such anticipation could be confidently relied upon especially when the analysts themselves are not well vexed with ‘Cash Management System‘ (CMS) adopted by the business leading to the granting of credit facility and appropriateness of such cash management system to the business after it has received credit-risk clearance.

In the theoretical practices of the Cash Management system, it focuses on how Cash flows ‘Into’ and ‘Out’ of the business at any point in time. In the principle of cash flow into the business, it is expected to flow within three sources of the venture. Which are;

–              Operational Activities

–              Investment Activities

–              Financing Activities

While the [Operational Activities] of the business consist of cash receivables from sales of products and services, cost of production, overhead expenses, account receivables, inventory, and current liabilities. The [Investment Activities] of the business are the dividends paid-out if any, emoluments payment and additional capital injections. And finally the [Financing Activities], which pertain to borrowing and loan repayments etc. Therefore, when a proper cash management system is ignored in a business, a promising venture could even become a victim of a ‘Cash Traps’. The consequence of ‘Cash Trap‘ holds 60% contributive factors to the 2017 collapsing Banks and 90% collapsing Savings & Loans companies in Ghana. It only under quality Cash Management practice that the business owners will be able to have a tabulating framework of realistic projections, monitoring collections, disbursement, and adherence to budgetary restrictions. As (Jordan, 2004) did submit, quality cash management does not only involves financial tools and techniques for managing liquidity but it entails an entire corporate culture, which implies the set of beliefs, expectation and basic principles shared by members of the organization.

In the competitive world of a business transaction, holding the wrong amount of cash or cash equivalent always interrupt the normal flow of business activities. Moreover, the wrong safety margin causes financial difficulties. This defines the very essence why there is the need for the ‘Cash Management Model‘ and it has become a prerequisite approach to business to uphold policy aimed at obtaining profits or reducing costs to generate value for the firms. Gallagher (2000) succinctly put it, Cash Management involves a trade-off between the need for liquidity and desire for profitability. This implies a very poor calculation of a firm financial management team in holding the right amount of cash to sustain liquidity or holding so many funds than needed and denied such cash for investment to other high return producing assets has a negative effect on the business. (Pandey, 2010) argued, one of the principal duties of the financial manager is to maintain an appropriate level of liquidity in the firm such that financial obligations can be honoured when it is due. Therefore when a business hold-on to excess cash as a safety margin, especially when it a debt facility from a Financial Institution with an interest to be paid on every unit of a dollar, it observed consequence is, most SMEs default to honour the entire debt facility during it half-way to the payback of secured credit facility. Other SMEs honours the debt facility at the detriment of a collapsing business after the payment of the debt due to poor cash management or the non-existence of a cash management system.

Realistic Cash Management Model

Appreciating the cause of the collapse of some of the promising prospective SMEs before their 3rd to 5th established year of existence despite having easy access to a credit facility. Then let examine two most popularly experimented ‘Cash Management model‘ in my experience very applicable in the context of African to some extent, furthermore, depends on how the business owners who understand their venture better than anybody applies it.

–              Miller-Orr model posits that the business adopting this model should structure it Cash Balance into two phases as the Upper and the Lower Limit. With the model instructing that the business will have to buy marketable securities when the cash balances of the business exceed the upper limit and quickly sell the securities to support budget when the cash balances fall below the lower limit.  However, this model is perfect to adopt only when the business is of a type not easy to predict its day-to-day inflows and outflow.

–              The second model is termed as Baumol Cash Management method in a simple put, this model holds the condition that, if the business owner could easily forecast the Cash requirements of the business with certainty and a steady rate of cash outflow. Then the business owner has to know the cash needed to conduct a transaction over a given planning period. And understand the opportunity cost of holding excess cash as a safety margin compared to the interest rate earned from marketable securities and its related cost, and establish the difference of earning to make a cash management decision.

Getting your business to be well equipped and resilient in a hostile economic climate with the support of investment is our priority as an Institute towards the contribution of a buoyant African economy.

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Emmanuel Tweneboah Senzu, is a professor of Economics & Investment, School of Social Science Njala University, Sierra Leone. Technical fellow to the Research Division of Sierra Leone Central Bank. The President of Frederic Bastiat Institute, Africa. †tsenzu706@gmail.com | www.fbiresearchedu.org

Post source : Library of Frederic Bastiat Institute

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