We are entering an environment in which interest rates are increasing quite sharply. South Africa experienced its biggest increase in borrowing rates in almost two decades and was simultaneously warned of a faster pace of hikes through next year. In mid-July the SA Reserve Bank’s monetary policy committee raised the repurchase interest rate to 5.5% from 4.75%.
Frank Knight, CEO of Debtsource – a specialist B2B credit management business – unpacks what this means for companies in the business-to-business (B2B) credit market. “B2B businesses may have become complacent. In a low interest rate market when companies extend credit to each other it doesn’t particularly matter if the debtor pays 15 or 30 days late. But the moment interest rates go up steeply, the cost of carrying that credit increases and some companies are going to go insolvent. Our level of legal work at the moment tells us that.”
He defines the cost of credit as the interest rate (the cost of your funding) plus the inflation rate (money losing its value over time) plus its opportunity cost to make a business more profitable.
“If a business was paid on time, it could for instance use that cash to negotiate a two and a half percent settlement discount from suppliers. If one does all the math of that in the current environment, a business is out of pocket approximately 20% with every extended credit which goes unpaid for a period of 12 months.”
“That extended credit of R100 000 is effectively R120 000 later on. Consequently, a rising interest rate has a severe impact on companies in terms of their collection processes,” says Knight.
While companies may not be able to influence their existing debtors’ book, Knight stresses they need to be far more selective in the future about which customers to sell to on credit and make far more certain that their processes are sufficient to collect payment as quickly as possible.
“In our business – where we run extensive legal and prelegal files for clients who sell on a B2B credit basis – we are seeing an immediate increase in this activity as interest rates start increasing and delinquency rates tick up. This is the reality of high interest rates: businesses get in trouble, cut back staff and people lose jobs. Credit insurers are right now preparing the market for bigger claims to come as companies go under.”
“Rising rates affects inflation, with the costs of a client’s business increasing thereby affecting its profitability and ability to recover existing debt from customers. Those customer businesses are themselves in turn battling to get paid by their customers and often losing them due to price increases.”
“This means you have to collect your debtor accounts that much quicker and scrutinise your cash flow more intensely than you would do in a lower rate environment.”
At the end of 2019 before the pandemic struck, the debt position in South Africa was not bad from a B2B credit perspective. This came notwithstanding the knocks of state capture and junk status imposed by rating agencies, as interest rates were at historical lows and the broader global economy was in a good space.
“Now the party is truly over, and companies need to adjust. Credit insurance is a good tool to prevent the effects of non-payment of a particular debtor in the event of an insolvency event like business rescue or liquidation. It looks at each and every debtor individually and approves limits on each.”
“On the other hand, invoice discounting is a form of finance whereby a company can be paid 85% of an invoice upfront improving the company’s cash flow – but it’s more expensive,” he says.
Reviewing the various options that businesses have, Knight says: “Credit insurance of local South African debt costs about 0,04% of turnover to insure debtors, thereby making it quite sensible for companies to insure their book as they can easily work that modest expense into their margin.”
However, Knight lists some common mistakes companies may make: “Invoice discounting, for instance, in some cases can actually worsen the credit profile of a business by charging excessive rates of 3-5% on each invoice. A business must be desperate to take up that kind of funding as annualised it is almost impossible to make up in margin.”
“Another problem occurs when companies give away too much security to a bank for their funding. Where a business needs a million rand in finance but gives the bank R10 million worth of security – trust me, they’ll take it.”
“Those are two pitfalls, but the biggest mistake of all is borrowing for the wrong reason. Often companies seek financing because they’re not focused on fixing the business’ credit extension problems correctly,” Knight concludes.
