The United States Credit Crunch
In our August and October 2007 newsletters we forecast that the US credit crunch combined with the Australian economy’s own issues will have a dramatic impact on our business landscape.
With the Australian economy showing signs of slowing, we take a look at what has happened during the last few months and where the Australian economy appears to be heading. We also provide a list of key initiatives for managers to use in preparing their business for an economic downturn.
US Credit Crisis
Although the Federal Reserve appears to have brought the US financial system back from the brink, the ongoing credit crunch continues to filter through global credit markets, including our own.
Experts are now predicting that the credit crisis will extend beyond 2008 as increased borrowing costs and reductions in available credit spread from corporations to consumers. This is expected to take the form of a tightening of controls around small business and consumer credit via a combination of higher interest rates and more stringent qualifying criteria.
The price of oil has risen 37% during 2008 to over US $130 per barrel. Although Australia has been somewhat sheltered from the fallout of the high oil price by the strengthening Aussie dollar, continued unrest in the Middle East, steadily rising demand, flat production and a weak US dollar continue to provide upward pressure on prices. Some analysts forecast prices of US $150-200 per barrel over the next 6 months to 2 years. Ever increasing fuel prices continue to hit business’ bottom line both directly in the form of increased fuel costs and indirectly via increased input costs.
Rising Labour Costs
The cost of attracting, securing and keeping appropriately qualified employees continues to be a burden to small and medium sized businesses. With unemployment at a 30 year low of 4.3% and an unprecedented number of public infrastructure projects competing for skilled labour, the current labour shortage is likely to continue for some time to come.
Rising Interest Rates
Borrowers have borne the brunt of four successive 25 basis point increases since August 2007, taking the official cash rate to 7.25%. The major banks have also added some increases of their own as they seek to pass on higher wholesale borrowing costs driven by the credit crisis. With inflation running consistently above the Reserve Bank’s target range analysts predict more rate increases this year.
The cost of servicing household debt is finally starting to slow discretionary expenditure. When coupled with increased fuel and food costs we expect the slowdown in the economy to broaden and accelerate.
Surging petrol, food, housing costs and increasing wages contributed to Australia’s annual core inflation rate of 4.4% in the first quarter, putting it outside the Reserve Bank’s target range of 2%–3%. Inflation is forecast to remain above 4% for the remainder of 2008 before falling to within the target range toward the end of 2010.
High Australian Dollar
The Aussie dollar has continued its rise from US $0.88 at the end of 2007 to all time highs of US $0.96. Although this reflects the current strength of our commodity market, a significant portion of these gains are due to the weakening US economy. With no end in sight, the strong Aussie dollar will continue to undermine the competitiveness of non-mining related exporters, and increase the profits of importers.
With all indicators pointing towards tougher times ahead, it’s time for management teams to focus on strengthening their balance sheet. This can be achieved by optimising working capital through initiatives such as:
Ensure Forecasts Are Up To Date: Now is the time to review processes which govern working capital and cash-flow decision-making. Robust systems will enable managers to identify needs and implement appropriate solutions on a timely basis.
Reduce Debtor Days: Strategies to reduce debtor days include:
- Incentivising staff to reduce overdue accounts
- Providing discounts to customers for early payment
- Strengthening reminder and debt collection processes
- Tightening the credit application process
- Implementing penalty charges for late payment
- Making sales staff accountable for client collections
- Using the 80/20 rule to cull low value/non-profitable customers
- Implementing cash only sales for certain circumstances
Tighten Cash-flow: Early identification of potential liquidity problems is vital in a slowing economy. Managers should increase focus on cash-flows through targeted internal reporting, and tightening controls on non-essential expenditure.
Stock Levels: Strategies to reduce stock levels include:
- Re-defining optimum stock levels of raw materials
- Reviewing batch processing levels
- 80/20 rule to liquidate obsolete & surplus stock
- Implement just in time purchasing
- Return usable excess raw materials to vendors
- Utilize inventory on consignment from suppliers
Consider Debtor Finance: Debtor finance can deliver a major boost to cash flow as debtors are sold to a third party financier.
Cull redundant products: Products which are no longer in-line with core operations should be identified, and a decision made as to whether to strategically increase their viability or remove them from the business’s product range.
Review Credit Arrangements: Paying creditors early (even if attractive discounts are offered) puts unnecessary pressure on working capital. Managers should also assess the strategic position of suppliers and identify opportunities to renegotiate agreements on more favourable terms.
Ensure Optimum Workforce: Employee remuneration and related costs are a significant expense for most businesses. Aligning employee numbers and remuneration with industry averages, and optimising available technologies to reduce labour input can assist in reducing employee expenses.
Some managers will have sufficient resources and time to execute these tasks. However, a significant number will require the expertise of corporate turnaround and performance improvement advisors to ensure a rapid and timely implementation.
For more information please feel free to contact one of the team at Vantage Performance.