|THE KNOCK-ON EFFECT OF JUNK STATUS (by Jonathan Faurie)
||Thursday 11 May 2017
|The economic environment in South Africa has been in a steady decline as economic growth has been hard to come by, and political instability has unfortunately taken centre stage in our daily lives.
This has had a profound effect on small to medium enterprises (SMEs) that rely on a specific client base as a source of income and on the financial services industry as smaller companies (underwriting management agencies and boutique insurers) have merged with larger insurers in the hope to access a bigger client base.
With South Africa's downgrade to junk status by two credit ratings agencies, this impact will only get worse.
The slippery slope
The knock-on effect of this will be that lending and seeking loans will become more costly for both South African consumers and businesses as interest rates and costs rise to adapt to this new volatile economic environment.
Speaking in a release to the media, Mark Paper - Chief Operating Officer at Business Partners International - says that when looking at how the increased cost of borrowing for South Africa will impact local SMEs, he explains that local businesses will feel the ripple effects from the increased burden placed on domestic banks, including their ability to service foreign currency obligations, as a result of the recent downgrades.
He points out that South African banks are directly impacted by South Africa's sovereign credit rating and as a result of the downgrade to junk status, S&P also downgraded South African banks to junk status.
"Thus an increase in borrowing costs by the domestic banks will, over time, put pressure on shareholder return. In order to bolster this return, banks will be forced to increase the cost of funds while reducing operating expenses both impacting on the South African SME ability to obtain and service loans," said Paper.
He further explains that these factors can be expected to have a ripple-effect for consumers who in light of increased interest rates, and rising prices, will have less disposable income. "These are all factors that influence the health of a small business’ cash flow at the end of the day," he says.
Keep moving forward
While investing in South Africa is deemed to be riskier than it was a couple of weeks ago, Paper says that this shouldn't deter SMEs from investing in their business and contributing to the country's economic recovery.
"While faced with these uncertain times, it doesn't mean that SMEs should suspend activity, or stop moving forward. Borrowing money, in good or bad times, can make a lot of business sense for well-managed companies," said Paper.
He stresses that in these uncertain times, there are several factors to consider when managing existing debt or seeking new funding. He pointed out that SMEs need to ensure that they understand the funding options that exist, as well as what type of funding is best suited to their needs - be it equity, long-term debt for fixed assets or shorter-term working capital - as this will determine who to approach, the term and price to pay, and what impact this will have on the business' cash flow.
SMEs should also be encouraged to seek expert advice prior to obtaining new funding.
Paper also advises SMEs to relook at their business plan and review ways in which they could improve performance. SMEs should get back to the basics of focusing on the selling the right product or service at the right price and not chasing turnover for turnover's sake.
If SMEs are providing credit terms to customers, Paper adds that business owners should have more emphasis on handling their debtors promptly and professionally to ensure their cash flow is not affected when it is needed.
"Every business has its share of slow-paying and non-paying customers. Bad debt is a problem for businesses of all sizes. This position is made even worse during difficult economic times, especially for a small business where one non-paying customer may be the difference between survival and failure," said Paper