What follows is not a political discussion on Brexit. Neither is it a debate on the merits of Brexit. If you get triggered reading the following, my best advice is to calmly breathe and close the browser window. Be forewarned, I will not approve any comments talking about ‘remainers’, ‘leavers’ or politics, so don’t waste your time. With that out-of-the-way, let’s get down to business.
A few weeks ago I met up with a friend of mine who is the finance director at a start-up. To say he looked tired and stressed would be an understatement. We talked about life and our families and then the subject turned to work. He clearly needed to get a lot off his chest. Because for him, Brexit is not some political Punch and Judy. It’s something he has to live and breathe every day as he wrestles every day with the fallout.
He’s not alone. Other finance and treasury-function people I talk to are having an equally tough time. For them, the frustration is as much the situation they are dealing with as it is that nobody is talking about it. Unfortunately, things such as Working Capital Financing, Currency Cash Flow Hedging and Cost of Capital Appraisal are not sexy. They don’t sell papers. But they have a huge hidden impact on our economy. My friend implored me: “Mr YFG! Please write about this!” So here I am, let’s give it a go.
A quick overview
The easiest way to see something is up is to have a look at the excellent Deloitte CFO Survey. Every quarter Deloitte interview roughly 100 or so CFOs of UK FTSE-listed and private companies asking them a range of questions. The headline figures are principally optimism and uncertainty. These being a kind of barometer to the inner workings in industry. The Q3 2018 report just came out and two figures jumped out to me:
The thing to take away from these two figures is not necessarily the overall levels of uncertainty and impact. Rather, what I think is important is the pattern – a distinctive ‘U shape‘. The peak in 2016 is understandable. A clear reaction to a sudden, momentous event. Over time, as we collectively got a better feel for what ‘Brexit’ was, uncertainty gradual ticked down. But over the past year, that trend has reversed.
That’s concerning because one would hope that as we got closer to the ‘day of reckoning’ we’d have a better collective understanding of what’s going to happen and plan accordingly. What this data tells me is that CFO’s are increasingly uncertain as we approach March 2019. Let’s have a look at three practical reasons why this is the case.
The message I’m hearing loudest is that the biggest issue isn’t employees or regulations. It’s cash. This shouldn’t be surprising. It’s the first thing you learn in accounting. Cash is all important.
Banks are being increasingly difficult in lending money to Small and Medium-sized Enterprises (SMEs). Whereas a year or two ago refinancing may have been trivially easy, some banks are dragging their feet. Most are still lending, but they use crafty tricks to make things slightly more difficult. These range from arguing over minor clauses in agreements, insisting on extra guarantors/security, through to ratcheting up every covenant as high as possible. You might be thinking, so what? Well, all that arguing gums up companies. It slows business decisions down. The finance team has to add extra financial metrics to monitor. The CEO and CFO spend more days in meetings with banks and lawyers, less time running their companies. It’s a drag. It’s costly. It has the impact of reducing investment. (FWIW: I’m not suggesting for a moment the big banks were particularly nice to SMEs pre-Brexit either…)
Likewise, Private Equity and Venture Capitalists are also getting cold feet. Many are choosing to sit out and watch what happens rather than making big bets. Sure, there are still big deals in the news. But beneath those big deals are 1,000s of SMEs and dozens of deals that used to be done that ain’t. Again, some start-ups which once could blink and get VCs swooning now almost have to beg to get them to the table. It’s important to remember we’re not talking valuation here. I’m not saying businesses are worth less because of Brexit – because I don’t know that! It’s simpler than that. It’s more difficult just to get people talking about valuation in the first place!
The thing that’s driving my friend most loopy is currency. As a young gent, I was busy playing with my legos when Black Wednesday hit. That was over 25 years ago. Unless you’re over the age of 50, it’s a challenge to remember a time when Sterling wasn’t a strong and stable (sorry) currency. We’ve been spoiled for a long time. Now, we are seeing Sterling move as much as +/- 5% in a month.
We hear a lot about how we, as a country, have to import goods. That kind of abstraction hides all the goings-on behind the scenes. Sure, queues at ports are a concern. But right now, businesses are spending more time just trying to get goods in the first place. These things range from suppliers no longer accepting payment in Sterling, to banks jacking up the cost of currency hedges through to, perhaps worse of all, suppliers refusing to commit to long-term supply contracts.
These things make planning long-term budgets incredibly difficult. But they still have to be done. The banks demand them, the investors demand them, employees need to know management is looking out for the future of the business. Unfortunately, Brexit hasn’t magicked up any more accountants (as far as I’m aware, maybe you think that’s a good thing!).
My friend is having a particularly tough time as his company works in consumer goods. Almost all raw materials are costed in dollars, almost all sales in pounds. Whereas once upon a time working out cost per unit and margin was trivially easy, now it’s almost a day-by-day calculation. Again, that’s more time spent on short-term, tactical decisions; less time on long-term strategic ones.
This is the area I’m most familiar with as it was/is my day job. I hope it’s not a leap at this point to say Brexit makes valuing businesses and projects more difficult. The impact of that is that where once a company might be able to make a big investment decision in a week/month, that decision now takes a month/year/not at all. This is not because Brexit may or may not make a business less valuable. If you’ve got two projects which are both expected to return £10m but one is doubly more uncertain than the other, you’ll invest in the more certain one. That’s common sense. Applied to business decision-making, when faced with more uncertain returns on projects, investments that you would have made before have now become too uncertain to invest in.
Just to reiterate, it’s kinda irrelevant whether Brexit ends up being the best (or worst) thing that’s ever happened to Britain. It’s the uncertainty that stifles investment. Going back to the port example that’s been touted around. The reason businesses are worried about that is not ‘the queues’, it’s hidden in the forecasts.
Let’s run through a hypothetical: say you’re a drinks company, looking to add smoothies to your product list. You buy the oranges in Euro from a farm in Valencia. Your margins, like most consumer goods businesses, are thin (you ain’t Nestle). Thankfully, you’ve got all your hedges in place (even if the cost is now double what it was before). As a small consumer goods business, you’ve been squeezing your working capital (net current assets) hard. You hold little inventory. You spend a great deal of time on cash collection and cycling as much of those sales back into operations as possible. Now, what if there is a one-day delay at the ports? Your little inventory dwindles, you get paid one-day later by your customers, but you still have to pay your supplier on time.
What about two-weeks? One-month? In those cases, that might be catastrophic for your company. It might also be catastrophic for your customers. It’s a flywheel. You are delayed, your customer is delayed. Everyone is delayed, you all get cash in later but still have bills to pay. Businesses run out of cash and go bust.
That risk went up from almost 0% before, to non-zero with Brexit. It probably won’t happen. In fact, it’s very likely not to happen (I surmise). But as a company owner, you have a duty to your employees, your customers, your suppliers to consider it. Over the long-term, your new smoothie business might make loads of money in the forecast. Demand for Valencia Orange smoothies surges (perhaps due to fewer Brits going on holiday to Spain). But that doesn’t matter if you run out of cash! So you might decide to hold back on investment. So too do the 10,000s of other SMEs up and down the country. That has a knock-on impact on the long-term growth of the country. And that’s why even such a ‘small’ thing such as queues at a port can be so important. It’s those hidden multiplicative effects.
I’ve focused on three things here – Treasury, Currency and Investment Appraisal. Many people would argue there are more important issues: hiring employees, consumer demand, tariffs. Those things are ubiquitous in the media. Those things are more tangibly obvious. I also wanted to give a peek into some of the things which are less often (never) talked about, but still matter, and show why they matter.
I know I’ve said this many times, but I will say it one final time. These things don’t turn on whether Brexit is a success or not. It’s, in some ways, irrelevant whether over the long-term Brexit is a good thing for Britain. These things turn on the uncertainty associated with any big change in economic direction of a society. They are important because hidden away, these effects multiply and can have an enormous impact on our businesses and economy. Unfortunately, that is lost in the shambolic political discourse of this country.
[A reminder: feel free to leave a comment. I would particularly like to hear from you if you own or work for an SME or start-up, I’m always very interested to hear from different viewpoints. However, I will not approve comments that talk politics or leavers/remainers or the usual Brexit fare. There are plenty of places to have those discussions, here is not one of them.]