OPINION
• Interest costs will siphon more (and more) cash from your business To break the cycle of inflation in the UK, the Bank of England has already raised interest rates half a dozen times. Interest levels rise because the bank needs to take away more of the money in our pockets to dampen demand. While mortgage holders may feel the pain when existing fixed-rate deals expire, business borrowing is typically more volatile. If your business currently has borrowings, now is the time to revisit and reassess whether you need to seek alternative finance sources. Businesses have three sources of funds: external borrowing, new (shareholder) capital or retained profit. If the business currently has borrowings due to mature in the near term, say within one to three years, you should work through the impact of a doubling and quadrupling of interest rates on your business. Remember interest is an outflow of cash that must be paid to avoid risk of foreclosure. Lenders often change their willingness to continue lending in times of uncertainty. You should therefore plan for different outcomes including current lenders refusing to renew loans, or potential lenders refusing to lend. Sounding out potential investors and setting out longer-term prospects for the business may help you line up new capital in time for when it will be needed. While retaining (full) ownership of the business is seen by many entrepreneurs as ‘non-negotiable’, this must be viewed dispassionately through a lens of business survival and long-term success. If, under different interest rate scenarios, a cash crisis could be looming for your business, now is the right time to review your funding options. Remember also that preserving funds, for example by deferring or cancelling planned dividends, retains vital cash and can send a powerful signal that gives suppliers confidence in the longer-term stability of the business. • Weak exchange rates will reduce long-term business profitability Businesses that rely on imports are suffering from higher costs of supply due to the decline in value of the British pound. While exchange
In uncertain economic times however, a domino effect will often take hold. Businesses not paid by customers are unable in turn to pay their own suppliers. Even dependable customers will delay (or default) on their payments, and this will eventually impact the ability of your business to pay its suppliers. Modelling the likelihood of customers delaying payment will help to identify cash shortfalls early. To address the challenge, consider changing terms of trade, starting with less dependable customers. Cash on delivery and/or offering early payment discounts may be a wise strategy to replace existing credit arrangements. In addition, limiting how much credit is given to any customer will dampen the impact of defaults. Wherever possible however, you should continue to honour existing payment terms with suppliers to maintain good business relationships and prevent working capital issues from becoming a contagion. “While retaining ownership is seen by many entrepreneurs as ‘non-negotiable’, this must be viewed through a lens of survival”
rates typically move up or down daily, the value of the pound may not rebound any time soon from its recent lows. Higher interest rates ought to have led to an appreciation of the currency, with overseas investors demanding UK currency. However, these rises have come at the same time as rising rates in the US and Europe. This, together with the UK’s Brexit decision and the government’s ‘current’ fiscal policy plans, may be conspiring to undermine confidence in the UK economy’s long-term prospects. Of course, no one can be certain what will happen with exchange rates, but business leaders would be wise to plan on the expectation that a higher cost base, brought about by higher exchange rates, is here to stay. Identifying opportunities to reduce cost of supply, for example by seeking out domestic sources, should go hand in hand with a detailed analysis of the cost base. Business costs can be classified as ‘fixed’ or ‘variable’ categories. Fixed costs do not vary with sales activity whereas variable costs, such as costs of selling stock, do. Businesses with high fixed costs suffer from high ‘operational gearing’, which means they are affected more acutely whenever trading profits decline. Investigating opportunities to reduce operational gearing will help the business manage in times of higher product costs.
• Customers will eat away at your working capital
A business must be profitable if it is to prosper and reward entrepreneurs for their many years of
effort. Many businesses may, on paper at least, be profitable but still find themselves with insufficient cash to meet their operational needs. The
cash (working capital) cycle explains how much cash is needed (and for what period of time) in order to avoid liquidity problems. Customers are typically offered credit terms by a business in the same way as suppliers give credit to a business.
Ambition | FEBRUARY 2023 | 41
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