With the increasing competition faced daily by businesses both locally and from new international entrants, companies are forced to seek growth either from their existing markets or possibly try to target new markets through export or diversification.
Very often they strive to increase their sales turnover in a short period of time by reducing their prices down to the very 'bone' to attract more customers. And the more their turnover increases, the more they continue trying to sell. This macho attitude will often lead businesses away from their true objectives of profitability and shareholder's wealth.
If a business wants to survive in a competitive market, it needs to plan how to grow or maintain the same market share profitably. Price, is not the only element by which competitive advantage can be gained. Products or services on offer can be differentiated in various ways keeping the price unchanged or even premium prices charged through quality improvements while still enticing demand.
There is also always a limit as to how much prices can be slashed and lack of awareness of a product's true cost can be disastrous for a company. The airline industry in general has suffered from companies slashing costs until they arrived to a point where the variable cost of operating a flight was higher than the revenue being attained, let alone making a contribution to the huge overheads that airlines have.
The supermarket industry is another typical example, not only in Malta but also overseas. In the UK, city analysts believe that price wars wiped four per cent off supermarkets' profits and billions off the stock market value of the most vulnerable supermarket chains. Tesco alone, the UK's largest supermarket chain, is estimated to have knocked £1.2bn off prices in the past five years. The same applies to the PC market. Companies are undercutting competitors in price at the expense of their long-term profitablity.
Sustainable business growth comes only from increased profitability. An unplanned rapid increase in the sales turnover is often at the expense of profit, which eventually could lead to the business' failure. Growing sales without proper financial planning are the perfect recipe for disaster.
Therefore, business expansion needs to be planned and controlled, and above all this needs a regular cashflow to sustain it. If cash inflow lags behind the cash outflow, the operating business will be in a state of cash shortfall, and this cash shortfall is very related to turnover.
Thus, unless this shortfall is anticipated and budgeted for, the business will run out of working capital and will not be able to meet its bills, pay interest charges, and more significantly the wages.
Therefore, management should forecast both the profitability and the cashflow effects arising from changes in the sales turnover, productivity and costs. Business expansion can only be based on a solid business plan, taking into consideration various factors such as the available capacity and the capabilities of the business. Additionally, one should always keep in mind that every business has its limited resources, which also need to be identified.
So, the first step to plan for growth is to ask three fundamental questions: "where are we now?", "where do we want to be?", and "how are we going to get there?". And these questions should be answered in the context of the wider business environment, offering constraints and external forces beyond the control of the business.
Prior to any decision to expand the operations of a business, the commercial viability and the market demand should be analysed: what is the available capacity and what are the capabilities of the business? Can the business expansion be managed by the available resources?
Is there enough capital to meet the required and the future ongoing costs? What is the use of expanding a business operation in a saturated market? What is the scope of opening a new retail outlet where one or more outlets selling homogenous products or services already exist down the same road or in the vicinity?
Presently, over-saturated market segments are found in various sectors of the Maltese economy, given the size of our island, but the more prominent examples are in catering, hardware stores, groceries, toys and stationeries and in the hotel industry. Another issue to consider when planning for growth is the legal implications which may exist when Malta joins the European Union in May. What effect will the Directive 2000/35/EC on combating late payment in commercial transactions have?
If the date or period for payment is not fixed in the contract of credit made by any two parties, interest at seven percentage points above the interest applied by the Central Bank of Malta at the time shall become payable automatically, without the necessity of a reminder, 30 days following the date of receipt by the debtor of the invoice or an equivalent request for payment. No one should therefore expect that the future is going to be the mirror of the past.
Over-trading companies, usually experiencing cash shortfall, will therefore be effected by this directive, and the easiest way to solve this predicted constraint is by extending more the credit facilities to be able to meet the amounts due in the short-term. So, the creditors should keep their eyes open to such situations and extend credit only to those clients who really are credit worthy and are able to honour their commitments.
Creditors should primarily analyse the cashflow of the credit - applicants since cashflow management is the life-blood of a growing business and the main indicator of business health. Moreover, looking at the present economic situation, it is becoming more important to be informed about how the clients' cashflow is managed. If credit is extended, or a credit facility is granted to a client who is not credit-worthy, it may have negative repercussions.
An effective means of being proactive is to form part of an industry credit group. Although a fair trading environment should be maintained, creditors coming from the same trade and sharing common customers can benefit from exchanging details of overtrading businesses, slow payers and defaulting accounts. Thus, sharing information about these accounts should result in minimising the risk associated with credit extension or even credit granting to new credit applicants.
The Malta Association of Credit Management (MACM) was primarily established in Malta to foster and facilitate the exchange of credit information, while promoting honest and fair dealings in credit transactions.
Among other activities, MACM members share mutual goals and credit problems, and by meeting with their peers in an Industry Credit Group they receive advance notice of problematic accounts and follow the payment patterns of common customers. Timely information regarding 'warning signs' may enable credit decisions to be taken more wisely, saving the trade creditor both time and money.
Josef Busuttil is an administrator for the Malta Association of Credit Management. He can be contacted on 2142-3638/9, by e-mail at jbusuttil@macm.org.mt or at 86/2, Triq ta' Mellu, Mosta. www.macm.org.mt.