Anyone who runs a business in Sub-Sahara Africa will have experienced how difficult it is to get a credit facility especially SME's.

From the banks perspective, their objective is to maintain as low an NPL (non performing loans) percentage as possible. In the past decade, it hasn't been uncommon to find NPL's at 20%+. Problem with that is banks take their customers deposits, lend it to other customers and make money on it from the interest they charge. When repayments are late or do not come at all, the bank lacks sufficient funds to pay interest on customers deposits and savings. Banks have to balance the maintenance of low NPL's with lending to SME's to drive economic growth. And unlike developed markets, banks in Sub-Sahara Africa have insufficient product offerings to make money from. Not to mention the limitations placed on them by central banks.

The question, however, is why are African businesses more likely to default than those in other markets? The map below from the IMF Global Financial Stability Report shows the percentage of NPL's vs total gross loans across the globe in 2017. The lighter the colour the lower the NPL's.

Bare in mind these are all loans not just to SME's. Ghana is at 22% and Nigeria 15%. Nigeria had managed to get the figure down to 6% by 2019, figures are yet to be published for Ghana. Whether this is because borrowers have changed their habits so are less likely to default or because banks are only loaning to those with a solid repayment record is unknown. Either way, there are a number of factors that seem to ail the continent and increase the likeliness of defaulting.

1 - High interest rate

Credit is not cheap on the continent. Interest rates well in excess of 20% is normal. The rate at which the Central bank lends to Retail banks dictates this, Retail banks have limited room to move. So, whilst on the face of it a businesses cash position looks good because they make a good profit margin between operational cost and revenue generated, this is all but wiped out by interest rate on any loan. Far from helping to support businesses to grow, in turn driving economic development, high interest rate credit facilities cripple businesses. All it takes is to lose one contract and a default becomes inevitable.

2 - Late payments by debtors

If a business is itself receiving late payments from its debtors, this puts a strain on operational expenses. Businesses are forced to prioritise what and who they pay with the reduced capital they have. If a debtor mismanages it's capital and they pay their suppliers or partners late, it does not damage their business or reputation. So, it is standard practice for big businesses to do this. After all, there is no one for the smaller business to hold them accountable to. Even if there was, the fear losing the contract means a late or missed payment here and there will be tolerated. And so the vicious cycle of late payments as a business norm is perpetuated.

3 - Lack of working capital

The point above contributes to this. Financial holes are left in the business, even if temporary, when buyers pay late or not at all. Businesses that are reliant one large key buyer are especially susceptible here. When they don't pay, product supply to smaller buyers is not possible. The timing of money coming into product based businesses is crucial to keep operations moving. Whilst the receipt of a contract from large buyers is to be celebrated, that contract should represent no more than 30% of a businesses customer base. If you lose 30% of revenue in a month, the business can still operate even if you have to supply a little late. Off course, this doesn't mean that the smaller buyers are not going to pay late but working with lots of them means any loss is negligible.

If you're at the commodities end of the supply chain, external factors such as price crashes due to over supply or reduced demand, crop failure due to infestation or disease, drought etc are real risks faced on a cyclical basis. Crop waste due to economic shutdown, as we've just experienced, can now be added to the list. In businesses where margins are low, any disruption on the sell side kills access to working capital. Index based insurance offerings can really help out here (though not with the new factor added to the list). Weather warnings are provided early and crop disease are spotted quickly alongside solutions to over come them. And more importantly, they pay out the much needed capital to get the business up and running again.

4 - Inefficient operations

The popular practice of hiring lots of people cheaply can and does inevitably cripple businesses. This deserves a write of it’s own. You get what you pay for as the adage goes. Far too many businesses are over staffed, lots of people performing small meaningless tasks that could be performed by less people or by machines. Whilst there is an argument that these businesses are creating jobs. This is true but often at their own expense, sacrificing quality of product and efficiency of operations. Hiring fewer people who can do the job well not only results in operational efficiency but business growth resulting the need to hire more people. Less skilled people can be hired in small numbers later, be trained and mentored by the highly skilled staff members, bringing them up to standard. The net impact on job creation is still the same.

5 - Open account transactions

Specifically addressing exporters, an open account transaction is a sale where the product is shipped and delivered before being paid for. Exporters in emerging markets, especially in Africa, feel pressured to agree to this because of fear of losing the sale to a competitor. But this means, they bare all the risks. It is not uncommon for importers to claim there was a discrepancy between the declared weight on the shipping documents and what was received or a percentage was spoiled/damaged on arrival. The exporter is left powerless to do anything accepting the buyers claims and reduced payment. Export credit insurance can be used to mitigate the risk of non-payment. Businesses can also agree to use this transaction type for an agreed testing period, reverting to a more favourable incoterm once the agreed period is over.

There are a number of ways SME's can prevent or reduce the likeliness of defaulting. Much of this is about been intentional about how you operate. Targeting contracts from large partners is as much a strategy as is going for lots of small ones as is hiring a small number of skilled staff vs lots of unskilled staff or agreeing to unfavourable trade terms. All have advantages and disadvantages. Doing a cost benefit analysis (no essay required) can help quickly reveal the impact on the business' bottom line.

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