01 May Interest expense V Profitability: Who dares wins
Who is taking the free cash flow as additional profit as the economic banking climate softens? You or your bank?
If you want to ensure your business is maximising its profitability, read Ian’s article…He’s ready to conduct a FREE CONSULTATION to analyse your business and assess its current position.
Interest Expense Vs Profitability: Who Dares Wins
If you dropped $100 out of your pocket, would you stop to pick it up?
What about $1,000?
What about $10,000?
This article is asking you to do just that. Stop, pause and pick up the money your business is haemorrhaging to improve your profitability.
A production focused business model will most likely involve a capital investment to return additional revenue. It is important not to confuse additional revenue with additional profit. Business expansion to drive profitability pushes the risk reward profile, but there is no such thing as a business operating under a risk free framework. So this additional capital expenditure is always at risk.
Assuming the simplified financial model of a business having to invest / expense $100,000 to generate a projected $10,000 profit, this $100,000 of capital is at risk.
The inverse is also true with expense management. A reduction in operational expenses may temporarily drive profitability, but what are the medium / long term profitability implications of the business from underinvestment in key inputs (repairs and maintenance, business development, marketing, research and development, input quality, human resource etc)? I call this capitalising future liabilities.
Banking to Agriculture hit a new high of $60.4billion with the interest expense being the HIGHEST input cost (representing 16% of the total expenses) for the industry totalling $5.023 billion (source: Neil Clarke Business Intelligence 2011; Agriculture’s seismic shift – a challenge for….)
Managing interest expense is the only item within the Profit and Loss statement that can be addressed that achieves the following;
1) It does not put scarce capital at risk
2) It reduces operational costs which has NO impact on the actual operational aspects of the business.
3) Improves profitability $ for $ and drops straight to the bottom line.
To flip the discussion towards your source of funds, ANZ recently raised 5 year money at only 85 basis points above swap. This is a material improvement from the 170 points from the tumultuous days post GFC, a time when the banks passed these costs down to their clients via their discretionary actions independent of the RBA announcements. So where have the other 85 points gone?
The argument is a little more technical and complex than it is noted above, but the underlying principle remains. The softening liquidity environment is supportive of interest cost compression. It is just a question of who takes the free cash flow as additional profit: the client or the banks?
Robinson Sewell Partners believes the client should participate in the economic benefits that are currently befalling the banks.
Please feel free call to discuss how Robinson Sewell Partners can ensure that your business is maximising profitability.
Director – Corporate and Agri Finance
Mobile: 0448 697 674
PO Box 8664
Kooringal NSW 2650