Why size matters (part 1)

Jun 30, 2020

Does your business fit into the definition of “Small Business”? Or for that matter, “Medium” or “Large” business? The definition varies from one industry group to another. And even within “Trade” it varies from one sub-group to another.

This table shows business sizes as grouped by StatsSA for South African industry sectors.

“Turnover” is the number at the head of your income statement. It does not include “other income” like grants, interest, rent, VAT and the like.

It is the sales turnover of your principal business, excluding VAT.

Those turnover groups have been varied from one industry to the next. My “hot air industries” notation is my slightly quirky reference to a whole bunch of consulting type activities.

The graph below will give you a more aerial view of the way in which sizes relate to one another and across different industries. There is no maximum for “large business”.

‘The one thing this country has taught me, Vaughn,’ said Griessel, ‘things never get as bad as you think they will. And things are never as good as you want them to be.’

Benny Griesel. The Last Hunt by Deon Meyer

So why are small businesses punching above their weight?

In the early stages of a business, the entrepreneur faces the envy of his friends who just don’t have the courage to chuck in the corporate environment and “go on their own”. Or they have to explain their risky behaviour to family members who feel insecure about the lack of “stable income”. But above all, they face their own fears, challenges, impostor syndromes, and bank managers.

Unless they make it big; and quickly, they are to be pitied. And that is also how they are treated when they ask for funding. But then along with the pity comes the distrust.

So to make my small business owner friends happy, here are a few metrics calculated directly from data supplied by StatsSA for 2018.

Just note that these numbers and conclusions drawn exclude banks, insurers, state owned enterprises, and the like.

Better negotiators

Small businesses managed to close off an average of 44% gross profit. The average GP% across all industries in 2018 was 41.5%. Not too shabby for my mates, eh? Gross profit is at the sharp end of running businesses, where the negotiating happens.

The small guys hold out for higher selling prices and convince their suppliers to give them better deals.

Look down the list: small businesses top most industries’ GP% where they have any chance. (There is not much space for negotiation in energy & water supply, mining & quarrying, and transport & communication.)

But for the other industries they do alright!

More working capital

NWC = current assets – current liabilities.

You will recognise that as the liquid assets available to first run the business, and second to build for the future. This you know because all business owners run that calculation last thing at night, first thing in the morning, and several times during the day. I’ve been told!

NWC is the single most useful day-to-day report metric for on-the-go management. If it is positive – you’re good. Negative, and it gets worse with the price of tranquilisers.

But when it comes to using it to compare with other companies it is fairly meaningless. Unless… A small tweak makes it extremely meaningful.

Net working capital ratio (NWCR) = current assets divided by current liabilities.

If the answer is above 1, then immediate liabilities are exceeded by what is available to pay them, now or reasonably soon. If the ratio is below 1, there is a problem now, or just around the corner.

Expressing net working capital as a ratio, we can compare the NWCR of a small business to a medium or large business. And within homogenous industries, these comparisons are very apt.

Any guesses?

For all industries combined in South Africa in 2018, NWCR = 1.15. It is positive. So there is that. But of course, I wouldn’t be writing this if the smaller businesses weren’t in the best shape of all the sizes. Here is the breakdown:

  • Small 1.47
  • Medium 1.36
  • Large 1.07

None of these are great numbers. Analysts like to see the ratio between 1.5 and 2. We’re all a bit tight here, as you may have heard.

But we do know that 1.47 is a lot better than 1.07. That’s small business for you – cashflush!

How does your business match up in each of these metrics? Remember the numbers quoted here are for 2018.

Step by step

  1. You know in which industry your business operates
  2. Place yourself in the appropriate size
  3. Gross profit ratio = gross profit / turnover
  4. Net working capital ratio = current assets / current liabilities

You can be quite sure that for 2020, those results will be very different. But we can only work with what we have, and I’m writing this with a view to showing up how unfair the system can be, and how the so-called “small business rescue packages” are actual, real, common or garden variety BS. And not the balance sheet type of BS.

To be continued…


Tags

Annual financial survey 2018, Corporate tax ratio, GP%, gross profit ratio, net working capital, net working capital ratio, small business performance, StatsSA, tax ratio, working capital, working capital requirements


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