Capital allocation during uncertain times

Businesses are still grappling with the ongoing effects of the economic slowdown as a result of COVID-19. Several entities have gone out of business and the capital allocation abilities and practices of many others have been greatly affected. However, all should not be doom and gloom.

As companies and businesses emerge from this slowdown, it is important now to establish a cash culture that prioritises cashflow and doesn’t tolerate unnecessarily tying up of capital. Companies should focus on cashflow and less on the blind pursuit of reported earnings.

Yes, cash is King as it is the blood that pumps through the veins of businesses and keeps them alive. It is paramount that business owners optimise cashflows from operations – and not have it tied up in uncollected debt from customers, slow moving stocks or other forms of unnecessary working capital.

Furthermore, liquidating unused or underused assets by disposing of more non-strategic brands, excess real estate and surplus research and development projects can go a long way in liquidity maximisation and preservation.

Due to Covid-19, supply chains all over the world have been disrupted. Businesses must strengthen relationships with their suppliers, and especially of capital such as commercial banks and creditors. Bank of Uganda has encouraged commercial banks to restructure loans maximum twice for their borrowing customers among other guidelines, giving business owners headroom to allow for better cashflow planning.

However, banks should not blindly accept restructuring proposals. They should commission independent business reviews of entities applying for loan restructures and particularly where amounts outstanding are material. This helps the bank to understand the likely impact of the pandemic on the client and ensure proper application of the restructures to limit the loan book deteriorating further and maximise chances of recovery, as well as protect the borrower.

Additionally, companies can consider re-negotiating credit terms with suppliers or seek out suppliers with more favourable credit terms to reduce the constraints on working capital and ensure liquidity in times of severe stress.
Other forms of capital such as intellectual, social and human capital should also be given consideration during these tough economic times as they are critical to long-term sustainable value creation. This is not just about companies quickly serving termination letters to their employees.

The very important question business owners should ask themselves is, “Will the continued lay-offs be sustainable in the long-run given the talent requirements of the entity?” However, it is important to note that there is no generic solution to the levels of intellectual, social and human capital that businesses may need, and this should be analysed on a case by case basis and in consideration of efficiencies that can be drawn from use of emerging technologies.

In conclusion, the economic shock brought about by Covid-19 is likely going to have negative long- term effects, varying between entities and sectors. For businesses to survive and thrive through and after this pandemic they need to refine their strategy for making capital allocation decisions. The most important guiding principles will be to balance these trade-offs: short term versus long term growth and low risk/low return versus high risk/high return.

Effective capital allocation by business owners should translate the choices they make into economic reality. In the long-term, companies must direct their capital to construct more resilient and robust business models prioritising financial solvency and sustainability.

Forms of capital
Creating value
Other forms of capital such as intellectual, social and human capital should also be given consideration during these tough economic times as they are critical to long-term sustainable value creation. This is not just about companies quickly serving termination letters to their employees.
The important question business owners should ask themselves is, “Will the continued lay-offs be sustainable in the long-run given the talent requirements of the entity?”

The author is a member of the Strategy and Transactions team at Ernst and Young Uganda.