Effective assets and liability handling for sustainable SMEs

CHIEDU IKONTA 

Chiedu Okonta, FCA, MBA (LBS), BSc accounting, a professional banker and an experienced Corporate Governance expert, is the chief executive officer of Rivergate Onyx Investment Limited, and the author of two books, Keys to Sustainable SMEs and Stamp Out Fraud From Your System. He can be reached  on +234 (0) 907 9103 248; and chieduokonta1@gmail.com (texts/chats/email only)

Contrary to the usual yearly practice where governments of nations allocate millions of dollars towards the building of sustainable SMEs, with the intention to accelerate economic development in their nations, to be successful in achieving position outcomes in that goal requires the implementation of what I outline as clearly cut out keys necessary for establishing sustainable SMEs. In addition to having a good foundation, viable products/services, effective handling of human resources, including succession plan, good accounting/accountability and optimal appropriation of annual income, any SME that needs to have sustainable growth, requires good management of its assets and liability.

Effective management of fixed assets: The general rule concerning management of SME fixed assets, especially motor vehicles, fixtures and fittings, and plant and machinery, is to only invest in them, when it is established that the SME business needs the particular asset. For example, where a bus is required, there is no point buying a Jeep, and if outsourcing plant and machinery at the initial stage, or using hire purchase is better, then, let it be done! The investment in these fixed assets should only be done in the overall best interest of the SME.

Building and land: Real sustainable growth of an SME cannot be achieved without a conscious effort to grow real estates at every available opportunity. In spite of the delicate nature of real estate acquisition and the risks associated with acquiring it, this remains an inevitable source of sustainable growth. The following tips about land and buildings acquisition may be useful:

1. Acquisition of land and buildings must be subjected to prior due diligence and extended due diligence involving the experts such as: lawyers, surveyors, architects, accountants and builders, etc. Each SME would always appreciate the discipline of basing every decision to buy or sell real estate on recommendation from the experts.
2. As much as it is practicable, it is far better for each SME to own its office building than to rent it. We would always support the idea of not overloading the business with expenses of fixed assets at the initial stage, but with proper planning, the financing of land and building can be seamlessly done without overburdening the business with immediate financial outlay.
3. Developing areas have the high tendency to grow. Identifying such areas ahead of time and investing in land and building at such locations ahead of the development may just open up great opportunities.  “Donald Trump – Real Estate 101’’
4. The value of SMEs investments in suitable land and building is of great importance to a lot of stakeholders; including bankers, investors, government, tax authorities and customers. The financial losses an SME incurs every year for operating without suitable land and building is unquantifiable! 

Advantages of owning land and building

The following are the immediate examples of benefits for an SME that owns its land buildings:

1. Overall less expensive compared to rent: The cumulative rent the SME would pay for five years of using the property would in most cases buy the property.
2. Tax benefits:  The SME that occupies its own property would eliminate the rent expense and in addition gain capital allowance, which indirectly make the building cost, a tax deductible expense.  
3. Other benefits: Any SME that operates in its own property is capable of enjoying (1) more liquidity over the useful part of the asset; as the cost that should have been incurred on rent payment is conserved. Other benefits of land and building include: (2) the associated prestige, (3) increased credibility; since it could be used as collateral to access banking facilities, and (4) capital appreciation as the property increases in value.

Effective management of liabilities

Liabilities are generally the obligations of the company to outsiders, including its creditors and owners. The below section seeks to highlight the key benefits from effective management of the SMEs liability profile:

1. Accrued expenses: This is a situation where the expenses are incurred in the course of the business, but the suppliers or contractors are settled in arrears. For instance, the following expenses: Salaries, Medical, Insurance, Communication, etc can be settled in arrears of 30, 60, or 90 days. It is a form of financing at zero interest rate; therefore, it is highly recommended, provided such expenses are incurred in respect of creating further wealth for the SME’s business.
2. Accounts payables:  These are the financial obligations of the company to its service providers, suppliers and contractors, for which their payments are deferred till the agreed future time of payment. Given that the business activity is progressive and viable, SMEs are encouraged to extend the time of paying for the Accounts Payable. For example, if the SME has the policy to pay its Accounts Payable 30 or 60 or 90 days after the goods are delivered or services rendered, then such a fund would boost working capital during that period.
3. Overdrafts and other short term loans: This is a form of liability where an SME borrows from a bank or other sources to finance its short term business activity. There is usually a cost in terms of interest etc attached to this liability. It is not advisable for an SME to accept this liability; except the business “annual return on investment” is at least twice the cost of borrowing and the amount borrowed can be repaid within the business cash circle. 

Many companies have witnessed tremendous growth within a short span of time due to utilisation of banking loans; while some other companies have crashed due to their utilisation of banking loans. It is therefore very important to know those factors necessary for successful utilisation of banking loans.

Who qualifies to borrow? 

1. The business entity that must borrow should be sure that the “yearly return on investment” for that company is at least twice the total cost of borrowing the loan. Annual return on investment is the profit of the company after paying all the expenses including tax, divided by shareholders’ funds. The shareholders fund is the capital invested plus the retained profit or reserve. The total cost of the loan is the interest rate plus all other charges.
2. For example: An SME made profit after tax of $100,000 in 2023. If the capital invested is $150,000 and the Reserve is $50,000, then, the Return on Investment should be $100,000/$200,000, which is 50 percent. If the interest rate is 20 percent and other charges are three percent (3%), then the total cost of borrowing is 23%. For this SME to be able to repay its debt, the SME “Return on Investment”, which is 50 percent, must be at least twice the total cost of borrowing, which is 23% in this case. So this company may take the overdraft.
3. Source of repayment: The next area to consider before taking a banking loan is the SME source of repayment. This is so vital because a bank loan is not a gratuity, but an obligation that must be settled. The source of repayment must be from the business being financed. If the business being financed generates inflows in 90 days and above, then it is wrong to obtain a banking loan with a 30 days’ maturity period.
4. The SME that must borrow should ensure its source of repayment comes earlier than the maturity period of the facility obtained. This has the great advantage of ensuring that default interest is not applied, if the facility becomes unpaid at maturity. Besides, an SME that has a consistent record of clearing its loan on or before maturity, secures credibility from the bank, which would assist the SME in future financing.

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