GROUND LEVEL
While borrowing can be a valuable way of boosting cashflow and liquidity, it comes at a price - and ironically, this can also serve to undermine liquidity in the medium term.
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cashflow position. Remember, though, that these services do not come free of charge. You might be slowly eroding profitability by bringing them on board, and at the most extreme level, you could be diminishing control of your own decision-making when it comes to selecting core customers and markets, as the insurance providers will often cover only those invoices sent to ‘approved’ businesses. Liquidity and borrowing – a two-edged sword Amongst lenders in the GCC, about 45 per cent of all loans are given on the basis of improving a business’ working capital. In many other regions, this would be seen as ‘circular’ borrowing that in practice digs an even deeper financial hole for the business to climb out of. While borrowing can be a valuable way of boosting cashflow and liquidity, it comes at a price and ironically, this can also serve to undermine liquidity in the medium term. The cash that now infuses the business may be lent at rates as high as 19 per cent (in the case of secondary or tertiary finance from a high street bank). This means that if your business is working to an overall margin of around 25 per cent - very typical for an SME in the service sector, for example - you could now be forced to work with a six per cent margin for the next five years. This may not be an issue while the funds from the loan are still ample and buoyant - but for how long will that be the case? This is why many lenders choose not to lend against working capital objectives, but will only do so against strategic expansion initiatives. Here, the prospect of potential income grows exponentially, meaning that the cost of the loan will be redeemed rapidly and not be severely felt. Whereas in terms of lending for working capital, the overall ‘pot’ only remains the same.
The wise SME will typically tend to retain strong liquidity outside of the need to borrow, but will then borrow in order to explore new markets, make acquisitions or acquire new equipment which can then be refinanced as needs arise (and note that asset refinancing can be an excellent and cost-effective way to boost liquidity). In these ways, liquidity needs to be seen as the basic starting point for strategic decisionmaking within the SME, and the preservation of strong liquidity needs to be the determining factor in both day-today operations and future planning. Here’s a useful exercise: what impact did your company’s actions and activities today have on the business’ liquidity and its ability to its way?
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For an online version, please visit: http://www.smeadvisor.com/groundlevel/the-quest-for-liquidity
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