Erosion Of Capital

Let’s face it. The cascading torrent of losses in the billions sustained by the *ahem* financial pillars of society, are no longer riveting. Lately, we’ve come to expect it in the same way as sewage leaks out of a ruptured pipe. For those doing the disclosing, their meltdown in the full glare of publicity might as well be the sequel to Al Gore's "An Inconvenient Truth".

Take Merrill Lynch for example. Not to bash, but reading the BBC’s online report for 17 January 2008 and Financial Times online report for 17 January 2008:

• In the last quarter of 2007, it lost US9.8 Billion – the biggest quarterly loss in its history;

• It made a net loss of US12.8 Billion in the 12 months ending on 31 December 2007;

• There were approx US15 Billion in asset writedowns:

• US3.1 Billion in contracts with bond insurers to hedge against losses;

• US9.9 Billion in *ahem* “asset-backed” CDOs;

• US1.6 Billion in its holdings of individual sub-prime mortgages;

So what’s the lesson for SMEs? The importance of enough working capital.

Merrill’s embarrassment, that eroded its market capitalization and its internal capital base, was attributable to debt and the assumptions made in respect of it. Specifically debt was very poorly assessed initially, then shunted “off balance sheet” via CDOs and SIVs, ceased to produce cash flow, could not be properly identified, could not be properly valued and ultimately had to be brought back on to the balance sheet and very publicly written down.

When one cuts through the artificial fancy corporate structures, the debt was intended to be a receivable that was supposed to generate regular cash flow. The entire sub-prime fiasco was a failure in receivables management that hit a company’s capital base and, in the case of Citigroup, its credit rating as well.

SMEs, focused either on survival or growth, often overlook the importance of receivables management. It’s handled in a haphazard or tardy fashion, only becoming urgent when the Accounts Receivables Ageing Report looks distinctly ugly, or the company faces a cash crunch like inability to meet payroll or rent. There’ll be some frantic activity for a few days to chase up on unpaid bills then it’ll die down again till the next AR Ageing Report or the next crisis.

In the meantime, the Receivables appear on the balance sheet as a Current Asset. That’s the formal way of saying “we’re keeping our fingers crossed and hope we get paid”. If the company doesn’t get paid for a while, their accountants will advise them to write it off as a Bad Debt. That’s a nice way of saying, “we’ve just lost capital we could have used”.

At that point, your SME is no different to Merrill Lynch or Citigroup. Bring on the firings, the tears and the downsizing.

Play your cards right, consistently tighten up on receivables management and the company could have predictable working capital for growth, overheads and a sweeter credit rating.

© 2008 Sanjeev Aaron Williams & Cashwerks All Rights Reserved