The Critical Issue of Cash Flow for SMEs

      Posted by Estefania Gual on Jul 2, 2018 in Newsletter

      The number one aim of small businesses is to become profitable, and quickly.  

      By nature, a small enterprise will have seasonal ups and downs and a cash cycle dictated by factors beyond their control, so ensuring they have enough cash in hand and are managing their cash flow correctly is critical.

      Profitable companies might see their cash reserves affected if they are moving too fast, and stagnating companies might find an unexpected liquidity issue unsurmountable. 

      Their issues, however, don’t stop there as they continue to be very much on the back foot when it comes to sourcing the help they need from their bank or any other financial institution, often relying heavily on credit lines for a wide variety of purchases and payments and other types of financial aid to support them as they grow.  

      New businesses may find lenders to be most scarce when credit is most necessary; not having a credit history makes them a risk some banks are unwilling to take.

      Entrepreneurs, freelancers and seedling companies have long been grouped with the individual, being banded together with solutions for the retail customer whose needs are incomparable with the financial needs of a business venture in its early stages.

      How to improve cash flow management

      Cash availability has a direct impact on how fast a company can reach its own financial objectives and how long the business can stay afloat. Being able to plan ahead to maintain a certain level of liquidity is paramount to success. But what do we need to take into account?

      • Cash flow:

      Cash flow is technically the difference between the amount of cash the company has at the beginning of an accounting period versus the amount of cash it has at the end.

      Typically cash flow describes the past, but there are also ways to predict cash flow for the near future. One option is to analyse patterns or trends within your business.

      Recurrences in incomes and expenses can be identified, so basing our estimations on calculations and historical behavior is a fairly foolproof way of predicting the future.

      Another option that might be even more relevant depending on the type of business would be to take future invoices and bills into account in order to estimate future cash flow. Depending on the country, invoices and bills can be paid up to 90 days after issue, and as a result businesses can plan ahead for the next 2 to 3 months.

      Estimating cash flow for the near future using these parameters can help the business gain a deeper understanding of the next concept: Liquidity.

      • Liquidity:

      This refers to the amount of cash an organization has to cover its immediate and short-term obligations.

      Costs might rise at any moment, so having a certain level of liquidity is the key to keeping a business up and running. There are also other related KPIs, such as optimum cash balance, which differs depending on the business, but that can normally be calculated by taking expenses for the next 2 months into account.

      Businesses can use this as a point of reference in most cases.  For example, if current liquidity is below the optimum cash balance, this might be considered a warning sign that further analysis is needed.

      • Profit:

      This refers to the surplus that remains after all expenses are deducted from revenue, and relates directly to the profitability of the business.

      Of course, we know that in practice, all of the above terms are interrelated. Where businesses lack funds to cover payments, liquidating assets can be a saving grace to help boost cash flow, meaning the more liquid said assets are, the better, as they are more easily “cashed-in” when money’s tight.

      It might be that a business is positive in cash flow and liquidity, without that necessary translating in profits- having enough cash to cover expenses now does not a profitable company make, if overall costs are greater than revenue.

      Where tight cash flow reverses fit with financial solutions

      Although the theory sounds simple, the reality is that many companies face financial challenges. Forecasting short-term cash flow is definitely a good practice to avoid certain issues, but are we aware of the most-common issues relating to cash flow?

      Liquidity shortage

      An SME is facing short-term difficulties, as monthly costs exceed current revenue. If nothing changes, this will become a liquidity issue and the company’s main checking account will go overdrawn in 3 days.

      As a solution, the bank can offer both an overdraft facility within a new business current account more suitable to its type of business, and a credit line to help overcome this short-term financial hurdle.


      Negative cash flow trend

      Cash flow has been decreasing over several months, potentially causing a liquidity issue in the near future.

      In order to anticipate that problem, the bank can offer a working capital loan to bridge this financial gap, and also open a new budget to keep expenses under control going forward.


      Substantial Planned Payments

      The SME pays its insurance at the same time every year. In this case, it’s due in 4 days and cash reserves are not sufficient to cover this large sum.

      This situation will generate a liquidity issue, so the bank offers an installment facility to control this payment discreetly and also the option of transferring money from one account to another.


      Large Unscheduled Expenses

      An SME needs to focus on doing business and generating revenue, so if cash reserves are low, an unscheduled payment might become a liquidity problem.

      In this case, the bank offers the possibility of factoring outstanding invoices, receiving 90% of the total invoiced amount straight away, as opposed to the full 90 days. For a small fee, this solves the current issue and avoids having to chase payments in the future. Another option it might be to release available cash from an emergency fund.

      Behind every problem there is an opportunity

      The reality is that these issues are part of the daily life of any SME, and these solutions are also part of a common portfolio of the average financial institution.  That is why being able to detect those moments where SMEs might potentially need solutions has become a hugely lucrative revenue source for banks.

      Banks are able to help SMEs anticipate future liquidity issues and avoid problems that may jeopardize their business.

      They can help them in many ways, such as getting the financing they need, establishing tax provisions, modifying the repayment terms on loans, reminding debtors to make their payments, taking the strain out of the logistical side of business and even giving them more time for the strategic, helping them grow and flourish.

      This is the start of a new Bank-SME partnership, a more-informed ecosystem and a ‘no surprises’ breed of money management. This could well signify the first step on the road to reducing the huge numbers of SMEs that fold within the first five years.


      If you are interested in finding out how Strands can help your bank, or if you would like to get a Free Demo of our AI-powered Financial Management solutions, please fill out this form and one of our Sales Reps will get back to you as soon as possible.



      Estefania Gual
      Estefania Gual

      Estefania is a FinTech product strategist. She has worked for leading digital core banking software and consulting firms and has extensive experience in offering high-quality technical and business insights.

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