The need for cash flow management stems from an inherent tension in most businesses—a tension that SMEs often feel more than larger enterprises:
Also, of course, businesses have fixed costs such as staff payments, rent on premises, lease payments on fixed assets, and the inevitable taxes.
Smoothing out the cash flow peaks and troughs from that inherent tension can help businesses stay on an even keel, so many SMEs find it helpful to devise a cash flow management strategy. Online tools can help businesses track incoming and outgoing payments on a daily basis and keep control of business expenses. Cash flow management tools can even be integrated with accounting software and payroll, giving business managers a complete picture of the financial health of their business. For international businesses, FX trading software can help them limit business risks from exchange rate movements.
Even with today’s online tools, however, many SMEs suffer cash flow volatility, or experience persistent timing differences between receipts and expenses. For these businesses, working capital finance can be an essential ingredient in their cash flow management strategy.
One widely available form of “working capital” finance is a bank overdraft facility—a line of credit that is drawn upon automatically when the balance on the business’ transaction (“checking”) account dips below zero. The drawn balance on an overdraft facility fluctuates with the company’s cash flow. The bank charges interest on the drawn balance, and there may be an additional “arrangement fee.” Depending on the size of the overdraft facility, the bank may require security such as a floating charge over the company’s assets.1
Running a permanent drawn balance on an overdraft facility can prove expensive, especially when interest rates rise. For one-off large payments, a bank loan may be a less expensive cash flow management alternative. Sometimes, too, business downturns result in a permanently drawn overdraft balance. Many banks prefer companies to convert permanent overdraft balances to medium-term loans. These days, there are numerous alternatives to traditional bank loans and overdrafts, such as U.S. Small Business Administration (SBA) loans,2 micro loans,4 and alternative finance such as peer-to-peer loans.4
For SMEs looking for a simple way to smooth out cash flow volatility, one of the most flexible forms of finance can be a business credit or charge card. A business credit card typically has an interest-free period, during which a company can pay a supplier without incurring interest charges, as would be the case with a bank overdraft. Some types of card allow the company to pay off the balance over a longer period, though this would incur an interest charge. Many business credit cards offer reward points or cash back schemes which can also help with cash flow management. Cards can also often be used to make payments in a different currency, though the exchange rate may be less favorable than if the business bought the currency itself, and some card providers charge commission. Cards typically have transaction fees and may have arrangement fees.
For SMEs that experience persistent cash flow strain, invoice discounting or factoring can be a good solution. Invoice factoring involves the business selling customer invoices to a third party. The SME receives funds earlier than it otherwise would, minus the third party’s fees, and customers pay the third party. In invoice discounting, the business borrows against the security of the invoices, rather than selling the invoices. Merchant finance is a form of invoice discounting that enables a business that accepts card payments to borrow against its expected future card receipts. These solutions can help SMEs to reduce or eliminate timing differences between customer receipts and expense payments. However, costs can be high, and factoring sometimes can disrupt customer relationships.
In today’s fast-moving, complex business world, an effective cash flow management strategy can be essential for a business’ bottom line. Using online tools to monitor cash movements on a daily basis, and incorporating a range of working capital finance alternatives to help manage cash flow variation, can help keep business costs low and relationships with customers and suppliers sweet.
With 17 years’ experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.
1. “Floating charge,” Investopedia; https://www.investopedia.com/terms/f/floating_charge.asp
2. “SBA Loans,” U.S. Small Business Association; https://www.sba.gov/funding-programs/loans
3. “13 top U.S. microlenders for your small business,” Marketwatch; https://www.marketwatch.com/story/13-top-us-microlenders-for-your-small-business-2017-01-05
4. “The history of U.S. peer to peer lending,” https://www.finder.com/p2p-lending-usa