The risks in small businesses and how invoice financing can help
In the face of today’s economic landscape, businesses are faced with a myriad of risks. This is more noticeable in smaller businesses, as there are lesser resources to leverage in times of need.
As a business is a dynamic structure, risks to businesses are ever-changing. However, there are the main types of risks that can be identified. Among these risks are business, financial, and operational risk. For the purpose of this article, we will further explore financial risk. Financial risk can be defined as the risk of cash insolvency which includes the risk of being unable to meet prior claims with the cash generated by the firm, which is determined by the dispersion of net cash flows, the level of fixed obligations and the business’s pool of liquid resources (Stephen C. Gabriel, 1980). In general terms, it can be understood as the risk of being unable to meet cash flow demands after taking into account of fixed costs and current liquid assets, most likely cash and cash equivalents for a small business.
Financial risk encompasses internal and external risks. Like the name suggests, external risks are risks that are beyond the control of the small business. External financial risks can include any risks that are not inherent to the business or industry, which includes adverse government regulations and hike in interest rates.
Government regulations
For small businesses that has only one core product offering, a regulation that is adverse can cause financial risks as it affects the demand of the product or the overall cost of production. Take for example a small company that manufactures and distributes juice based soft drinks as their core product and the recently enforced Soft Drinks Industry Levy in the U.K will now increase the prices of the finished good. The small business will have a harder time to compete with other larger firms who have greater margins due to economies of scale while suffering from decreased demand as the price of the product increases.
Interest rates
For small businesses, hike in interest rates or the London Inter bank Offered Rate (LIBOR) can mean greater interest rates on business borrowings. For smaller businesses, these rates are immediately reflected in their Profit and Loss accounts and can put a dent into their profits as they juggle with short term business loans to cover any short-term business needs.
However, there are financial risks that businesses are exposed to that are dependent on how they have managed their finances, including credit and cash flow risks.
Businesses that are poised to grow may suddenly require a huge amount of working capital where they are suddenly too highly geared. Gearing in financial term is basically the proportion of debt to equity and this also concerns the liquidity of the small business. A company that is too highly geared will lead to many problems, among them liquidity and cash flow problems. Product based small businesses may stockpile inventory in preparation for a high seasonal sale or that they have problem with slow moving goods that are building up, hence having liquidity problem as their cash and cash equivalents dip. This may affect the business’s ability to cover the fixed costs and other working capital requirements.
To mitigate this risk, a small business can consider using invoice finance. Invoice financing is the act of selling an invoice at a discount to a lender while receiving advanced cash flow. When the customer repays the invoice, the small business will repay the full invoice amount to the lender.
As risks are defined as events that has a probability of occurring, risks can be manageable. Manage your cash flow risk now and visit our website to learn more about invoice finance and how we can help.
Lou Chan, Populous World.
