Small businesses have possibly never faced more challenging trading conditions, but there are measures to take that can help mitigate the impact of the looming downturn.
A combination of rampant inflation, high taxes, soaring energy costs and shrinking economic growth has left SMEs - many of whom are still recovering from the impact of pandemic prevention measures - wondering what more they can do to survive.
In terms of practical steps SMEs can take to alleviate cost burden, the Federation of Small Businesses (FSB) recommends businesses first make sure they are using all the reliefs available to them, including the Employment Allowance, which was increased from £4000 to £5000 as part of the Spring Statement.
Steps that can be taken to minimise late payments include:
- Issuing invoices on time and implementing a system for tracking payments
- Using an online system that issues invoices and reminders automatically
- Agreeing on clear payment terms when signing new clients and contracts
- Assessing billing processes to determine if terms are too lenient
- Evaluating how late payments are chased
Those businesses that have managed to remain profitable should look to build a cash reserve that can be used to cover anticipated expenses or rising costs and set aside money across VAT and income tax return periods to cushion the blow of paying their tax bills.
The August interest rate increase will be of little solace to those with borrowings, but small business owners with savings should shop around to see if they can take advantage. To date, few banks have passed on the increase, but this may change over the coming weeks and months, and it always pays to see what is available from other financial institutions.
Those who are members of small business groups should take advantage of the services available from these organisations. For example, the FSB provides access to a legal advice line and a debt recovery service.
Managing cash flow
Another area of focus should be working capital or cash flow - the money available to cover financial commitments such as salaries or stock purchases.
Debt-to-earnings levels for SMEs are at an all-time high, as companies took advantage of cheap debt prior to and during the pandemic when government intervention kept credit market pricing low. This has left them vulnerable as earnings come under pressure due to demand slowdown, input cost inflation, and higher debt pricing.
“The real challenge facing small and mid-sized companies is that the credit spread applied to smaller, sub-investment grade companies has increased much faster than the same measure for large companies,” explains Alistair Baxter, head of receivables finance at working capital solutions provider, Taulia.
Keeping up with inflation
This leaves SMEs facing a key strategic decision - weather the storm or find growth and outpace inflation. In either of these scenarios working capital management has a crucial role to play.
All companies have receivables, trapping cash for as much as 90 days or more. In the current double-digit inflation environment, this means that small and mid-sized suppliers are seeing their margins eroded by around 2.5% between delivering goods and receiving payment.
“Taking an early payment on these receivables is a highly effective tool to mitigate the real impact of inflation by getting your cash sooner,” says Baxter. “Less cash trapped in invoices will in turn allow companies to rely less on debt - providing vital breathing room as pricing increases, while also freeing them up to find areas of growth and opportunity.”
Some large companies offer supply chain financing or dynamic discounting to their suppliers, which is a cost-effective way of receiving early payment on receivables.
An alternative working capital solution is accounts receivable finance, which allows sellers to take control of their own balance sheet and cash by selling the receivables to a financier through an integrated technology platform.
A proactive approach to cash flow management will highlight potential problems not just now but in the near future too, and a key element of this is scenario analysis. This type of planning is useful for assessing how cash flow would be impacted by a specific increase in supplier costs.
- Investigate all possible sources of business relief, even if you don’t think you would qualify
- Review your invoicing and payment collection processes to give your business the best chance of getting paid on time
- If you’re fortunate enough to have surplus cash in the business, make sure it is either earning some interest and/or providing a buffer for higher costs
- Explore working capital management options such as offering discounts for early payment