During periods of economic uncertainty a business should prioritise its survival. In the current situation there is global uncertainty brought about by the COVID-19 pandemic. Some of the challenges emanating therefrom include:
- Reduced global economic activity.
- Disruption to imports, for example from China and South Africa. Some of the imports from these countries are required for resale or as production inputs.
- Reduced local production may impact export volumes. Exports lead times may lengthen.
- Local economic activity is currently restricted due to various measures to contain the pandemic.
- Businesses will continue to incur overheads notwithstanding. These overheads include rentals, employee costs and capacity maintenance costs. This will erode working capital.
- The informal sector, which includes the self – employed, is affected and thin on working capital. Their owners rely heavily on business cashflows for a living. Prolonged periods of constrained economic activity may erode or exhaust working capital.
Working Capital
In simple terms working capital refers to funds which a business uses to fund its day to day operations. It is the lifeblood of an organisation. Examples of items from a business’ Statement of Financial Position (formerly “Balance Sheet”) that make up working capital include:
| Current Assets | Current Liabilities |
| Inventories / Raw materials | Trade Creditors e.g. suppliers |
| Inventories / Finished Goods | Prepayments by customers |
| Debtors / receivables | Short term loans |
| Prepayments to suppliers | Bank Overdrafts |
| Cash and Bank | Unpaid Taxes |
Current or short term assets change their form regularly, for example from inventories to debtors or cash and bank as a company trades. Current or short term liabilities should be monitored and settled within agreed timeframes to avoid financial distress.
Measures to manage working capital
During a period of economic crisis such as caused by reduced economic activity or inflation working capital can be eroded. For example payments for overheads or price increases by suppliers ahead of a business’ own price reviews can militate against a company’s working capital base. A business should therefore proactively preserve its working capital or risk failure. Below are some of the measures that may be adopted:
- Accounting records. Produce regular complete accounting records which show the financial position of the business including current assets and current liabilities.
- Monitor working capital. This is done through monitoring values and key ratios. Key ratios which compare current assets and current liabilities are the current ratio and quick ratio.
- Cost containment. Generally costs should be contained. Overheads such as rent, employee costs, capacity maintenance costs and other administrative should be contained.
- Stock levels. Consider adequate stocks having regard to lead times which may have changed.
- Credit policy. Screen credit customers, collect amounts on time and minimise bad debts.
- Prepayments to suppliers. Can be minimised through negotiating credit terms though this may be difficult for imports.
- Cash balances. Balance between holding adequate transactional cash and bank balances and the risk of erosion of those balances by inflation. Subject to laws, consider hedging. Some businesses invest in listed equities which are easily convertible.
- Creditors. Negotiate credit terms with suppliers as these are a good source of cheap finance.
- Customer deposits. A business can ask for deposits or down payments from its customers.
- Use of borrowings. Bank borrowings can be used to bridge temporary funding gaps.
- Living expenses. Small to medium businesses and those who are self- employed have to be extra careful. Drawings for personal living expenses of owners can easily erode business working capital.
- Use cashflow management tools. Use cashflow management tools to forecast, monitor and manage liquidity. Space permitting I will write a separate article thereon.
Godknows Hofisi is a legal practitioner, chartered accountant, corporate rescue practitioner, and consultant in deal structuring and tax. He writes in his personal capacity. He can be contacted on +263 772 246 900 or gohofisi@gmail.com
