…responsible debt management for businesses and households
Debt, a double-edged sword with the potential to propel or cripple financial health, is a crucial aspect of economic well-being, whether at the national, corporate or household level. In Ghana, as in other nations, responsible debt management is the key to sustainable growth and financial prosperity.
Understanding debt sustainability
Debt sustainability is an entity’s ability, be it a sovereign nation, a company, a household or an individual to meet debt obligations without jeopardising other financial commitments. It is the fine line between financial prosperity and instability. While national debt is a significant topic, businesses and households are foundational components of a nation’s financial stability. Responsible debt management is essential at all levels.
Corporate debt sustainability
Responsible debt management remains critical for businesses in Ghana. Companies require financial flexibility for investment, innovation and resilience during economic downturns. Excessive debt can hinder adaptability and growth potential. Maintaining good credit ratings is vital, as it allows access to funding at favourable interest rates.
Responsible debt management for companies also leads to operational efficiency. High debt levels result in increased interest payments, which can erode profitability. By directing resources toward productive endeavours, businesses can bolster their long-term financial health.
Individual debt management
On the home front, individuals in Ghana are also making strategic choices regarding mortgages and personal loans. Managing the debt-to-income ratio, avoiding unnecessary borrowing, and maintaining a balanced debt portfolio is essential. Budgeting and creating an emergency savings fund act as safeguards against unexpected financial challenges.
Indicators for corporate debt capacity
Several financial ratios are crucial in assessing a company’s financial health and its ability to manage debt obligations:
- Free cash flow to debt service ratio: Ideally well above 1x, this ratio indicates whether a company can comfortably cover its debt payments. A ratio above 1x signifies that the company generates sufficient free cash flow to meet its debt obligations without straining its resources. For example, if a company makes GH¢10,000 a month and its debt payment is GH¢5,000, the ratio is 2x, indicating they can easily cover their debt.
- Earnings to interest service ratio: A higher ratio here is favourable because it signifies that the company can effortlessly service its interest payments. For instance, if a company’s interest expense is GH¢2,000, and they earn GH¢4,000, their ratio is 2x, showing they can easily cover the interest.
- Debt to earnings ratio: Lower values in this ratio indicate the company’s ability to effectively use its earnings to reduce its debt burden. If a business, for instance, earns GH¢50,000 and has a debt of GH¢10,000, its ratio is 0.2x, suggesting it can use its earnings to pay off its debt.
- Debt to equity ratio: Lower values suggest a more conservative capital structure, reducing financial risk. This ratio reflects a prudent approach to managing a company’s financial structure, which can be reassuring to investors and creditors alike. If a company’s debt is GH¢20,000, and equity (ownership) is GH¢80,000, their ratio is 0.25x, indicating a conservative capital structure and reduced financial risk.
Positive impact of responsible debt management
Responsible debt management has consistently yielded favourable outcomes, benefitting not only the business sector, but also the overall national economy. This approach has driven significant growth, extensive infrastructure development and technological advancements.
For example, entities like COCOBOD judiciously employ debt as a financial tool to support the cocoa industry. This sustains the entire cocoa value chain, ensuring the livelihoods of countless individuals involved in cocoa cultivation and the subsequent production of chocolate and related products. Responsible debt use bolsters the cocoa sector and contributes to the broader agricultural industry and Ghana’s export capacity.
Importers of refined petroleum products play a pivotal role in ensuring the smooth functioning of the nation’s transportation and energy infrastructure. These enterprises often rely on bank debt to maintain the consistent supply of fuel and energy resources essential for Ghana’s economy and society.
In a broader context, responsible debt management has become a driving force behind economic prosperity in many nations – even the strongest of economies. It provides the necessary financial resources to stimulate growth, fund critical infrastructure projects, and fuel technological progress. This, in turn, leads to increased economic opportunities, improved living standards, and a more dynamic business landscape.
Warning signs of excessive debt
Excessive debt can lead to dire consequences, manifesting through telltale signs such as a high debt-to-earnings ratio, rapid debt accumulation, high-interest expenses relative to earnings, and the inability to meet debt payments.
Strategies for finding the right balance
Businesses in Ghana can adopt strategies to strike the right balance between utilising debt for growth and avoiding over-leverage:
- Comprehensive assessment of debt capacity: Evaluate the company’s financial health and its ability to generate consistent and substantial cash flows to service the debt and provide a cushion for unexpected events.
- Using debt for the right purpose: Prioritise using debt for initiatives that foster growth and enhance overall value.
- Mitigating risks: Identify and mitigate potential pitfalls, including strategies to handle interest rate and exchange rate risks.
- Diversifying funding sources: Avoid overreliance on a single source of debt financing.
Financial institutions’ role in responsible debt management
Financial institutions like banks play a crucial role in educating businesses and individuals about responsible debt management. They offer education, responsible lending practices, and alternative financial solutions where applicable.
First National Bank supporting clients in debt management
First National Bank Ghana stands out for its commitment to support clients in optimising their debt capacity while managing risks. The bank acts as a trusted advisor, providing technical competence to help clients determine their optimal debt capacity. They support clients throughout the credit lifecycle, ensuring responsible debt management.
The Executive Director of First National Bank, Sylvia Inkoom, explained that as lenders they are genuinely interested in the prosperity of their clients, so their approach to banking and lending was based on a partnership and a long-term view with their customers. She also mentioned that this approach has built trust and put the bank in a position where they could be trusted advisors to their clients.
“We ride the tides with our clients through the cycles of the credit lifecycle, from the process of credit origination, assessment and post-credit approval, until it is used and fully paid off,” she added. The bank has also proven structures and human resource who are technically competent to help clients with the determination of debt capacity and determining optimal debt levels for their clients. “This is the most important step in the credit conversation,” she emphasised.
The bank executive also mentioned that on an ongoing basis, they help support their clients through constant engagement to ensure that they take all the right actions in the interest of their business and is operated in a sustainable manner. She noted that they had partnerships with development partners, donor organisations and other entities engaged in such social intervention to provide loans at reasonably low rates for their customers.
“We have partnerships with development partners, donor organisations and other entities engaged in such social intervention to provide loans at reasonably low rates for our customers. We are currently finalising a similar arrangement with the Mastercard Foundation to support clients in the Agric business value chain with concessionary loans and technical support,” she further stated.
As a member of the FirstRand Group, First National Bank also has access to information, expertise and support that provides advisory services, corporate finance solutions, and other non-debt financial support to their clients. The path to financial prosperity is a journey of balance, and First National Bank Ghana is happy to walk side by side with its clients – be it businesses seeking sustainable growth or individuals seeking their personal financial well-being.
