LIBRAE
5.5 Value Chain Analysis
5.5.1 Financial Control (Budget)
A budget committee or team with the appropriate budgeting skills should be established to make realistic budget estimations. This budget could be set as an interim and then on annual basis. The current wide discrepancies may imply that an Investment Manager or Economist with adequate hedging risk knowledge is essential for the Cooperative.
An investment/economist expert will be able to advise the organization of forthcoming and level of prevailing interest rates, inflation and provide knowledge of the operation of the capital markets and use the techniques of the money market to hedge away the inherent risks that prevail from exchange rates. If this fact is not taken seriously by the Cooperative, substantial losses could be incurred and the effects could be worse in the long-term sustainability of the Cooperative. Focus should be on increasing operating profit margins and increasing turnover as indicated by the Du Pont Analysis to improve the financial situation.
5.5.1.1 Costs Reduction
Unbundling (Vertical de-integration) strategies: SASCCO should investigate reducing costs by implementing offensive strategies to increase revenues. Initiatives to capitalize on competitor weaknesses should be taken by concentrating to services where rivals have weak geographic concentration. Special attention should be paid to buyer segments neglected by rivals and more focus should be placed on the core business of the Cooperative by providing superior customer services.
5.5.1.2 Control of Expenditure
Management can cut expenditure on communications by monitoring the telephones, faxes and cell phones closely to ensure that they are not abused. The cell phone bills could be substituted by giving deserving officers (as per management's discretion) allowances with set limits.
Management could also revisit the communications budget estimates to ensure their authenticity.
5.5.1.3 Consultancy and Training Income
Since this item brings small revenue to the organization, it could be improved to generate more income for the business by training more staff in this area alternatively, it could be invested into other profitable portfolios within the Cooperative before it becomes a drain to the whole SASCCO's overall profits.
5.5.1.4 Sundry Expenses
Much expenditure has to be cut from this non-descript item. The losses on investments could, for instance, imply use of more hedging techniques to bring down the level of expenditure. Bank charges could be reduced by investing the Cooperative's revenues generated with other financial institutions that offer higher income or give more interest on deposits. Legal fees should be altogether avoided by adhering with all the accounting standards applicable. Too much money is spent on staff uniforms. If uniform allowances are given, the level of expenditure could be reduced substantially.
5.5.1.5 Board Sitting Allowances
Management is advised to adhere to the budgeted estimates as they seem to be reasonable and do not overspent on this item as it has serious implications to management. A contingency plan needs to be developed to accommodate unforeseen meetings and circumstances.
5.5.1.6 Optimal Capital Structure
The optimal capital structure is one that reduces the overall cost of capital to its lowest level, thus increasing the overall value of the company. Capital structure optimization's choice will depend on the company's financial risk, which is primarily influenced by degree of operating business risk and the nature of debt. The company should determine its own desirable optimal structure mix, so as to avoid high gearing.
For instance, in case of accelerating depreciation, the additional borrowing may not reduce the company's tax bill immediately, but simply cause additional losses to be carried forward. As long as SASCCO is able to mix its equity structure proportionately by securing debt to lower interest charges to gain tax shields, the Cooperative stands the chance of survival. If not, then the likelihood is very strong that SASCCO will fall victim to bankruptcy.
5.5.1.7 Gearing the Cooperative
SASCCO should introduce more debt into its capital structure to help reduce its insolvency. There are two main factors that need to be considered when dealing with gearing. The first one is that it is a cheaper form of financing than equity because of its tax benefits. Secondly, the more debt issued the larger the risk of the company defaulting which tends to make shareholders worry of highly geared firms. The implication of more gearing is that the shareholders will require a greater rate of return with increased risk. Financial risk will arise from the increased variability of dividends payments to the shareholders which then push up the overall cost of capital. The advantages of debt outweigh its disadvantages. Equity, for instance, besides the fact that it is expensive, is very inflexible as growth depends purely on reinvesting earnings and the ability of the owners to provide new funding and can cause dilution via new shareholders.
Based on the evaluation results of SASCCO, a recommended average level of debt as part of the Cooperative's capital structure would be around 60%. A high debt-to-equity ratio would help strengthen manager's focus, ensuring that they view cash as a scarce resource and allocate capital accordingly. Moreover, management can create new ways to work the balance sheet by managing the physical capital, and deploying or eliminating unproductive capital both as fixed and working capital.
The Cooperative should ensure that future debt maturations are sufficiently spaced apart to allow for the recovery periods. These should be in line with free cash flows available to be able to finance the loans. Once the company has recovered and is no longer in danger of bankruptcy, it should refocus its efforts on funding with short-term debt as opposed to long-term debt to provide flexibility. Gearing will reduce the deficit.
5.5.1.8 Future Equity
It is recommended that once the Cooperative has recovered from the deficit and starts to be
profitable it could raise new capital from its retained earnings. When a company wants to issue equity investors may believe, rightly or wrongly, that the company is doing this because it thinks its shares are overpaid and may respond by selling them. In addition preservation of retained earnings would be good for SASCCO to develop and encourage more projects expansion into the Cooperative.
5.5.1.9 Mid-Term Financing
The association should consider mid term financing methods when purchasing assets. The most suitable financing method for IT assets would be an operational lease. Since the Cooperative's highest asset value is its computers and software, it could lease these items operationally rather than buying them. When using the balance sheet figures, if the computers and software amount is removed it means that the fixed assets amount will reduce since operational leases are off-balance sheet items.
The association should note that diversification will lower the risk of the portfolio. The Cooperative could also opt for other asset allocations. This is a technique that divides assets into major categories in order to create diversification and balance the risk. The main objective of mid- term financing is to choose the most cost effective financing method in order to maximize shareholders' wealth. At this stage, medium term debt is encouraged to keep the cost of borrowing low. This will also reduce interest costs, compared to funding with unsecured notes. Lower interest costs should be taken advantage of to plough back money into the business, thereby reducing the business risk.
The main advantage of an operational lease is that the interest cost is tax deductible. This form of leasing provides an alternative means for obtaining use of an asset without purchasing it. The lessee normally does not intend to have a permanent title of the asset, Correia, Flynn, Uliana and Wormald (2000). The term of the lease agreement is usually shorter than the asset's useful life.
The lessor assumes the responsibility for maintenance and the insurance of the asset, hence, these assets become an off-balance sheet item, and the rentals deducted in the profit and loss account.
This will provide a room for the Cooperative to have use of the most up-to-date equipment since it will be able to lease upgraded machinery at the end of the lease contract. This form of leasing is also regarded as the cheapest that SASCCO could predict with certainty its future base payments
and budget accordingly and borrowing at an almost risk free rate. Furthermore, operational leases can, with notice, be terminated at any time.
5.5.1.10 Portfolio Diversification
There is a great need for SASCCO to generate higher profits for the sole purpose of reinvesting the profits into the organization to engage in more activities. It cannot rely only on donations. This is why the association has been incurring losses for the past four years. The continuation of the association's activities is dependent upon its ability to operate profitably, and on the availability of ongoing finance from its members and finance providers.
Over reliance on the African Alliance fund can bring negative returns to the Cooperative. At the moment, it can be seen that investments to this fund alone consist more than 75% of the overall portfolio. The fund is perceived to be a large-cap stock, implying that it has great financial strength and stability. However, when the economy performs badly the share price for large-caps falls, though still holds better than small-cap stock funds. A typical fund is likely to have a broad range of products and services that can help them weather economic storms.
As a practical matter it makes more sense to invest both in large and small capital stocks.
Investment should be in terms of how these stocks will perform over longer and shorter periods and to balance between the desire for the lowest possible risk and the highest possible return to trade-off risk. Investment with the Old Mutual fund seems to be reasonable and in tact due to the professional management, diversification, and economies of scale, simplicity and liquidity of the fund. It should, however be noted that mutual funds are always associated with high costs, over diversification, possible tax consequences and the inability of management to guarantee a superior return as is already the case with the Cooperative, it incurs substantial charges to Old Mutual.
Recent research studies have shown that a well-diversified stock portfolio must include at the very least thirty stocks for a lending investor and fourty stocks for a borrowing investor. An optimal portfolio for SASCCO means deciding on how much risk the Cooperative can handle and then allocate its assets accordingly.
5.5.1.11 Conducting both External and Internal Audits
Annual external audits and quarterly internal audits for the Cooperative are highly recommended
to gain investor confidence that the Cooperative is still operating as a going concern.
5.5.1.12 Pension Fund and Medical Aid Scheme
A pension fund and a medical aid scheme for SASCCO employees would be necessary for the apex body, however, some organizations are now moving away from providing these services.
5.5.1.13 Expansion Projects Encouraged
Establishment of further structures by the society is encouraged since it adds value and image to the organization but this move should not cause the agency problems by depriving members' rights to loans as their savings would be locked up in the fancy building constructions.
The proposed working structure of the Cooperative Bank should aim to work hand-in-hand with the individual societies. ATMs could be installed in selected places around the country to enable distant members' easy access to their funds.
5.5.1.14 Taxation
SASCCO is advised to put some measures in place to ensure that the Cooperatives members are not double taxed by the CBS's move to tax the Cooperative.
5.5.1.15 Credit Control Facilities
The Cooperative should encourage strong regulatory policies to cater for the low income earners who become heavily indebted because of the heavy deductions effected directly from their salaries. With the increasing formalization of the savings and credit industry, SASCCO needs to install accelerated investment computerization system software that will recruit only members who are financially cleared with other financial agencies or members who have approved financial credibility.
5.5.1.16 Counselling Programme for Indebted Customers
A debt-counselling programme by SASCCO is recommended to help members who are heavily indebted to control this kind of situation. This will not only reflect the Cooperative's responsibility for the community/members but will also bring a good reputation for the Cooperative. Such initiative has a potential of attracting many clients into the Cooperative thus, increasing SASCCO's base for its members who from the analysis conducted in Chapter Four reflected to be
the main source of funding for the Cooperative. It is further suggested that the Cooperative in its by-laws, ensures a law that will assist the borrower a right to defend a claim of indebtedness.