3 Tips to UK SME's Navigating A New Financial Paradigm
“Interest rates” are the buzz-word of the moment, but beyond the newspapers and the impact on your variable-rate mortgage, what does this new financial paradigm mean for the UK’s SME market?
We have lived in extraordinary times, with risk capital in abundance and interest rates near zero for over 12 years. For many, this has been a period of high growth. An opportunity to borrow at historically cheap levels, fuelling a wave of M&A and Capex investment. But for others, zero interest rates have been the ventilator supporting inefficient business models and financial laziness. Diligence has laxed as valuation multiples continued to extend into the clouds.
As a business owner today, the reality is setting in. Learning how to operate and not use the last 12 years as an indicator for growth, value or borrowing capacity is crucial.
Whilst we at RCA are not macroeconomic forecasters, the cover image to this article showing Bank of England Interest Rate changes gives insight into where we sit historically. (You can also use the link below)
https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp
Who knows where we will be 5 years from now, but here are 3 things you should look out for in a period of greater financial uncertainty.
Are you light in Accounting & Analysis?
Typically, most owner-managed businesses we see either employ a mid-level FD or act themselves as a quasi-CFO/CEO.
This has worked well for many when they’ve used the business as a nest-egg for their lifestyle but as financial conditions worsen we see more and more owner-managed businesses unaware of their true financial performance. By nature, they’re reactive and are caught fire fighting situations rather than building out projections based upon key assumptions on underlying changes to changes in interest expenses and COGS.
Now is the time to truly question whether you have the internal tools and people to help you navigate these uncertain times. Invest in a true FD or CFO and give them the authority and autonomy to succeed.
2. Change you cost culture
As mentioned before, for many this period of low interest rates has created a laziness around financial diligence. Ask yourself:
Are you reviewing your cost and revenue hubs regularly?
Are you renegotiating contracts?
Are you cutting the slackers?
Are you creating a culture driven by contribution margin?
Who is leading this culture change and how are your team compensated for extracting costs and margin?
For many, change is slow. Now is in fact the time to pull the band aid off. Don’t be left regretting making a good decision quickly.
3. The past is not an indicator for the future
Recency bias is a dangerous cognitive behaviour that affects many of us. Whether it’s your business’ value, your margin or your ability to make the decisions your business needs to do today.
Today interest rates are sitting at 4% and risk premiums have increased as well.
So what does that mean?
If you’re lucky enough to be borrowing at or above 2-3% base your interest rate expenses have skyrocketed;
If you’re looking to take on growth capital you need to look closer than ever on your Return On Invested Capital (ROIC). If you’re fortunate enough to find debt, it’ll likely be in the form of Preferred Equity north of 12% p.a with warrants. If you’re taking on equity, be prepared to have your valuation expectations tempered.
True inflation to many of the businesses we’ve seen is closer to 10-15% and in many cases is closer to 25%. Many are experiencing record periods of sales growth yet this isn’t being reflected in the bottom line (EBITDA and FCF).
Periods like this are where we see mean reversions. Good quality businesses are struggling and those that have strung onto life during the last 12 years are now being exposed for their inefficiencies. Anecdotally, we’re seeing more and more businesses that are either close to trading insolvently or are going into administration.
Opportunity is rife for those that can navigate through this, control their costs and take calculated risks to grow inorganically. But that all starts with making a change and viewing your business, interest rates and this financial environment with a different lense.
Business owners today need to be driven not by the past but by underlying assumptions about what the future may or may not bring.
Where will staff costs be a year from now? Have you tempered expectations and communicated the reality of this period? How will you motivate and incentivise your staff during this time?
Have you secured supplier contracts and hedged your risks to increased COGS?
Are your sales contracts linked to CPI? How often are you reviewing your prices?
What happens to your interest expenses if the BOE base rate increases 1-2%?
To ignore the potential of this new financial paradigm and be reactive is a gamble you and your business can’t afford to take.