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Corridan Financials
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Credit Crunch
The Credit Crunch and how it affects business; large, small and in between.
The credit crunch is all about the cost of borrowing and the availability of capital.
Those institutions that make money available to business, either through loans, overdrafts, credit cards or purchase finance are becoming more risk averse. Because the industry has had to write off more debts due to business failure and bankruptcy than planned, this is affecting their profit. It also indicates that the industry has lent money to people or businesses that could not afford to pay it back.
What does this mean to small business?
There are a couple of issues.
1. The Availability of capital.
Firstly the issue of lending money to people who cannot prove they can afford the cost of paying back the loan or credit plus interest. Business owners will find that they will need to provide more evidence of future income and stability that before. Businesses with confirmed order books and future contracts guaranteeing income will find it easier to obtain credit and capital than entrepreneurs with a great idea but little evidence of future cash income.
2. The hurdles to obtain capital
Where previously a sole trader, partner or small limited company could go to their bank and reasonably expect them to provide support in terms of an overdraft facility, without securing this finance with a personal asset or guarantee, they may now find that the bank or institution wants more comfort that the money will be repaid. The business owner may find they are asked to provide something that the lender can repossess to give them comfort that they will get their money back if the business fails.
3. The cost of borrowing
Secondly to ensure their profit margins the financial institutions will increase the cost of borrowing to higher risk business or business owners. Fore instance it is possible that two similar businesses may apply for a loan. Both may be accepted, however the one with a guaranteed income and profit may find that the interest rate applied on the loan repayment is lower that for the business without guaranteed income and profit, also that they are not asked to secure the loan with property or guarantees.
Looking at this from a day to day perspective.
If a small business is financed by borrowing money, and the cost of borrowing in interest rate terms has increased then the profit margin will need to increase to pay for this. This potentially will mean that small business will need to look at increasing prices or cutting costs. In addition to this ensuring that cash flow is under control will be paramount. A sale is not a sale unless the cash has arrived. Those businesses who can show that their forecast of income is based on good collection of customer debts will reduce the financial services industry’s perception of how risky the business is.
Small and Medium size firms are likely to become nervous more quickly if a customer does not pay their bills on time. The result of this is likely to be realised in the addition of late payment interest charges and/or faster legal action to recover the debt.
On the receiving end of this action we may find more small and medium size businesses, not completely in control of their cash flow, with court judgements against them. This will than reduce their ability to obtain finance and increase the cost, as they will, in the eyes of the financial services industry, become more risky to lend money to.
So what about the large organisations who rely on small and medium size business for their support services?
Small and medium size business will begin to vote with their feet if there is a choice of working with an organisation who pays quickly versus one who looks for 90 days credit.
Large organisations may find that they themselves are subject to more credit control actions from small businesses in an effort to keep their cash flow under control.
In this period of uncertain future due to the credit crunch, large organisation have a duty to trade fairly with small and medium size businesses.
Pay invoices when due, not late
Develop a payment policy that is geared to small business
• Payment made as soon as physically possible
• Straight forward approval systems
Finally when engaging small and medium size businesses, recognise that they need to make a profit. Do not force a supplier to reduce their price to such a level that they become too risky for their bank or other financial institutions to support.
Margaret Corridan A.C.M.A
(Treasurer - FSB East Berks Branch)
Tel: 01344 989869
Mob: 07798 933876
For management and finance training that gets results
For accounting commercial finance support in plain English
www.corridanfinancials.com
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