The traditional finance source for SMEs is the bank overdraft. In a typical trading instance this will allow cheques to be written for wages till cash is received from debtors, and it may cover many other trading and general expenses. But finance charges may be steep, so prudent owners will take steps to minimise the overdraft balance, and always check for more suitable alternatives.
Here are 3 steps to work through to optimise your business finances.
1 – Consider alternate sources short term finance options available which may be a better fit
· Invoice discounting
The arithmetic takes a bit of getting used to but invoice discounting can be a good option to accelerate the “working capital cycle” without increasing the overdraft.
· Bridging loans
These might be more suitable than overdraft for short term purposes till the loan is cleared by longer term arrangements.
· Personal loans and credits are a way to access new sources of finance if loans based on business assets have been maxed out.
But they are more risky and could be more expensive.
Acquire equipment without capital outlay! Of course you are still being charged interest, by another name.
· Commercial bill endorsement
Create an unconditional order to pay at a future date and sell it to a bank. Use bills for short term purposes, such as seasonal variations. Variable rates and usually less than 180 days.
· Export finance
Specialist services are available from trading banks if you are thinking of exporting or importing.
Beware buying fixed assets or investments with an overdraft
Short term overdrafts are not suitable for financing long term assets. For one thing they are repayable on short notice – unlike the assets they finance which are not.
If liquidity is a risk, term loans and leases are more suitable even if more expensive.
Finance companies are the second most accessed source of finance for small companies offering alternative sources for most of the above.
2 – Cut expenses
An obvious way to reduce an overdraft is to cull spending. But try to avoid becoming an Al’ Chainsaw Dunlap in the process, wrecking operations with short term savings. Sensible budgeting and cost reduction programs may help.
1. An operational budget
· If you are a new business using an operational budget as a yardstick to measure finance progress may seem low on the priorities, but it just makes good sense.
· It can help control the big picture gross profits as well as line items.
· And drill down by product, region, location
· Corrective action can be taken as necessary to manage adverse variances.
2. Zero based budgeting and other cost reduction programs
· One way to create a budget is to make it zero based. A zero based budget achieves 2 useful goals, as each cost is scrutinised from the bottom up to see if every cent is really necessary, and that the costs and benefits have been optimised. Simultaneously you will have a yardstick against which to measure actual costs.
· Another is activity based costing analysis which tries to look at the cost by activity rather than type – it may be that non-core activities are actually consuming disproportionate amounts of cash and need to be culled.
3 – Reduce total working capital
Working capital costs money. The bottom line is that whatever balances the business has in stock and debtors, (less the portion provided free by creditors), is financed either by overdraft, or cash which could be earning interest elsewhere (an opportunity cost).
So, take steps to reduce total working capital to minimums to reduce the level of overdraft by reducing the stock, debtors and increasing creditors if possible.
Again, how does working capital work?!
Cash flows in a cycle into, around and out of a business. It is the business’s life blood and every manager’s task is to keep it flowing and use it to generate profits, and to keep it low because:
• First, if debtors are slow to pay, they will be costing you in interest in 2 ways.
• It works like this. If a small business operates on credit the overdraft may be in use to finance timing differences in a negative cash cycle where creditors are paid before debtors pay you, and the more growth the bigger this problem becomes.
• Second, the more debtors / stock a business has on hand, the bigger the outright investment in working capital, in addition to the timing problem
Suggestions to reduce working capital
In a nutshell, do whatever it takes to
– minimize stock yet still keep the business flowing
– collect debts promptly while maintaining customer relationships
– use trade creditor finance to the maximum
You might take a stock inventory and examine slow moving items and only carry minimum stock levels of active lines.
Operate well defined trade agreements with credit customers with clearly communicated collection procedures. Consider changing your terms of trade, reducing the period of credit given.