Corporate debt management

In the main and social media news last week was the declaration of a debt “default” by the banks of an emerging business conglomerate for failure to pay an installment. This was for a large loan of a subsidiary company, which likely carried a cross-default provision that could trigger the other related companies to be also in default. The conglomerate issued a statement after two days, that payment has been made and they aren’t in default, but this was after the stock prices of all their listed companies fell by 5% to 7% in the Philippine Stock Exchange, and their financial reputation damaged.

I had previously written a column on personal debt management where we explained over-borrowing and how ironic that the lower earners/classes have to pay interest to informal lenders of up to 200% p.a., 72% p.a. to motorcycle and appliance dealers, and 36% p.a. to credit card companies. We advocated to avoid these kind of debts and to negotiate for restructuring and reduction of interest rates. Corporations have better options and access to credit than individuals and SMSEs, but the basic strategies and tactics of debt management are the same.

Debt is important for most businesses to grow and for the efficient use of capital. Except for technology companies that have to be funded by equity capital from angel investors, venture capitalist and hedge funds as startups until they become bankable, most companies borrow or are leveraged optimally. This makes debt management critical in any business as it demonstrates management capability, capacity, and competence in managing finances and business.

Capacity to carry and service optimal debt has to do with the balance sheet structure, the debt to equity proportion needed to carry the business, whether in manufacturing, marketing, or services. Understanding the cash flows of business will determine the ideal debt to equity proportion and the maximum leverage tolerable. Revenues and income in the books are not necessarily cash flows but accounting entries that becomes cash only when they are collected. In understanding the cash flow cycles, you determine your debt service burden, net operating cash flows per period, and make you understand your business better.

An important component of debt management both for individuals and businesses is backup liquidity. These are unappropriated cash and marketable assets that can be used to shore up or meet payments. For service companies like banks and finance companies, these are the required and secondary reserves which are cash deposits and marketable securities. Most large companies also have these reserves together with committed bank credit lines which they can avail at any time. For smaller companies, these would be loans from kind relatives and friends.

Another component of corporate debt management would be awareness and understanding the macro-economic environment. The Asian debt crisis and the Wall Street meltdown in the last 30 years were unanticipated events that put many companies unable to service their debts or even survive. Those that had sound capital structure and good management survived and subsequently prosper, but those who had macro-economic appreciation did even better as they were prepared for it and were not vulnerable. I worked for two large companies during these crisis years and both survived after restructuring loans and unloading some valuable assets. Although billions were still left to the children and some of the companies, the differing outcomes had to do with vulnerability and available liquidity.

We can presume that these large conglomerates have the professionals and expertise on their finance team. Still, we should be aware that rapid expansion and growth tends to leave debt capability and capacity behind, leading to management gaps which may be costly. As a businessman, professional manager, and Finance professor, I see and practice debt management from all sides. And this is a major factor in successful entrepreneurship.