You don’t need additional financing and this is why!
You don’t need additional financing and this is why!
When interviewing businesses, we often hear that one of the biggest challenges faced is the inability to access financing and the high cost of the financing they do access. Our experience, on the other hand, is that often the problem doesn’t lie in accessing capital but in a very inefficient use of available capital.
Take for instance one of our clients, a construction company with a turnover of KES 200 million a year. Its operating margin (profit before interest and tax) last year hit KES 22 million, an enviable figure for many businesses. However, because of the total debt of KES 100 million, it paid KES 19 million in interest, with after-tax profit falling to KES 2 million. That is a measly 1% net profit margin!
A closer look into its operations showed that 80% of the business was generated by interior design, the company’s core competence. The remaining 20% came from exterior construction or “wet works” that was not really its specialty and that was much less profitable. On the other hand, “wet works” are very capital-intensive. Exterior construction, corresponding to 20% of sales, employed over 60% of capital.
Eliminating “wet works” from their offer may have reduced the turnover by KES 40 million and the operating margin by 2 million, but also significantly reduced the financing needs, thereby saving KES 11 million in interest costs and raising the net profit from 2 million to over 8 million! In contrast, if they had solely focused on reducing the interest rate they were paying from, say 19% to 18%, they would only have had savings of 1 million and, taking into account the tax shield effect, increased their net profit from 2 million to roughly only 2.7 million.
We see the same pattern in practically all industries locally: investing in unnecessary assets like an extra truck for a distribution business, blocking huge sums in slow-moving goods in a retail business, and numerous other cases. In most of them, the right way to improve profitability consists not in running after cheaper financing, but in eliminating operations that unproductively employ the capital available.
At ISBI we pay huge attention to identifying the improvement potential in the utilization of capital for the participants of our programs. We develop tailor-made solutions and, most importantly, train our entrepreneurs to spot and solve such issues by themselves in the future.
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