Nearly all businesses houses wish that boom economic times should in continue in perpetuity. The reality, however, is different and businesses have to face tough economic periods from time to time. Tough times call for more diligent and cautious approach though it is not uncommon that businesses, particularly SME’s take rash and risky decisions during these times in anticipation of positive results even where the probability of achieving those results is low.
SME’s with insufficient cash flow find it difficult to sail through the ebb of the economic slowdown. The situation is only worsened by slow recovery and/or defaults from existing customers which in turn could lead to a serious threat for the continuity of the business.
Many SME do not survive a long-drawn downturn as they make several common mistakes in tough times:
There is always a pressure on reduced sales and reduced margins in a tough market. Many entities, out of desperation, accept orders with very slim margins. Due to cost overruns such slim margins ultimately results in further loss to the entity. Some entities accept lower margin orders as a strategic move to reduce losses however such should be done with extreme caution and with continuous monitoring. Such strategy might work where the downturn is for a short period however if the downturn is expected to last for a longer period than the strategy will back fire.
Sell or agree to sell for an extended period of credit. SME’s often fall prey to supply goods and services to customers with an unreasonable long credit period. The management should always be extra cautious when a customer wants an undue extended credit period and conduct proper inquiries regarding the creditworthiness of the customer. Here the SME is exposed both to a cash crunch and more than normal likeliness of default.
As the SME would face cash flow shortages in a downturn, they often resort to seek additional funding from banks. Banks normally are not very keen to fund in such economic times for working capital finance. SME’s might, in such case, borrow against off books assets to fill the gap. Bank funding costs would thus increase the overheads for the SME. In the event of a default from the customer, the SME would face several threats; increase in overheads, default or untimely servicing of bank loans, attachment of assets by the banks and even criminal proceedings if the situation worsens.
Business planning and allocation of resources are essential for any business. Some SME’s do a forecast of numbers on a wrong notion that the downturn will not last long and thus a non-conventional approach is taken. Forecasting a rosy future with little or no back up cashflow would further land the business in dire straits. As sales forecast is high, the overheads resources allocation too is high. Where the said sales are not achieved the entity will still have to bear the high overheads.
Cash based overheads would be required to be paid by the businesses whether sales performance is good or slow. Failure to cut unnecessary overheads on a timely basis will be a heavy strain on the cash flow and result in additional losses to the entity.