If there’s one thing that we constantly stress about lending to businesses it’s the fact that it’s the unpredictable macro-environment that causes business the most trouble and, more often than not, is the major cause of business failure, especially when management is slow to respond to negative events or miss them completely.
A perfect example of this fact is the publication today of the annual results of Clover, a major South African manufacturer and distributor of dairy and fruit products. Its revenue increased during the year by 2.4% (in an economy in which inflation is around 6%) but its operating profit fell by a whopping 44%.
But what’s interesting are the reasons given by the executive for this dramatic drop.
- Last year’s drought is blamed for an increase in input costs as the availability of raw milk and fruit pulp decreased, sending their prices higher. The company couldn’t pass these higher costs on to consumers as the economy is performing poorly and disposable income is weak.
- Then, the opposite occurred in the main rainfall season in the north of the country in the Johannesburg/Pretoria region. There, as the drought came to an end, the summer was wetter and cooler than usual, affecting consumer demand.
- Finally, the other major culprit is the volatile exchange rate as the South African currency has been weakening over the past year or so but shows signs of recovery from time to time.
The really interesting point, however, is that the executive don’t blame themselves or their decisions – everything is the fault of external factors, which is probably true up to a point. But if you’re the lender to this company, you would have to wonder whether the executive really have a good grasp of the risks and the ways in which these risks can be mitigated.
It does underline one key point that we often make in our training; a good lending decision is based on an understanding of the drivers of revenue, profit and cash flow and the impact of these drivers on the business in the future, not in the past. And that applies to businesses of all sizes, not just the big guys.