With recessionary fears looming, here’s how SMBs can prepare for what’s ahead
By Tom Joerger Director of Operations
Considering the current economic climate, the rate of inflation and a potential recession looming, preparing workable solutions to implement ahead of financially stringent times is imperative for small and mid-sized businesses (SMBs) who don’t have the resources and financial stability of larger organizations. Because of these limitations, traditional financing options from bank loans to lines of credit aren’t always accessible or sufficient.
Small to mid-sized businesses can turn to alternative funding solutions to finance their operations, investments and growth. But first, let’s understand the importance of cash flow (hint: it’s the lifeline of SMBs); current market trends and regulations, and the impact of banks increasing borrowing costs.
Cash flow and traditional funding obstacles
Cash flow is the lifeline of SMBs; I can’t stress this enough. Given the current economic climate — and past experience from the 2009 crisis that hit the global economy hard — recession preparedness is a discussion to be had by executives in all industries. In fact, a report completed by ForwardAI found that small businesses regard cash flow to be one of their top five challenges, and 60% of failed SMBs cited cash flow as the root cause.
“Unfortunately, a lot of small and medium-sized businesses (SMBs) struggle with cash flow because they fail to collect invoices,” according to Forbes contributor and finance council member Nick Chiani. And a survey by QuickBooks showed that mid-sized businesses surveyed were owed $304,066 on average in late customer payments, and 81% of these respondents said “their customers had been late on their payments more often in 2021 compared to previous years.” That’s money these companies have rightfully earned, but they’re not able to access or spend. Delays in payments can mean financial trouble such as lack of funding for operations, and customarily, SMBs would seek assistance from the financial sector and traditional funding.
However, market research also demonstrates that banks are tightening loan standards, making qualifying criteria stricter or inflexible in the shorter term. Obstacles that arise from traditional funding for SMBs include:
- Stricter qualification requirements — Typically requiring a strong credit history, collateral, and a proven track record for profitability that small or mid-sized businesses haven’t been able to yet establish.
- Slow approval processes — Banks often take weeks or even months to approve a loan, which can significantly derail a company’s business operations and growth opportunities.
- Limited flexibility in terms of repayment and interest rates — SMBs have limited bargaining power when it comes to negotiating favorable loan terms.
- A lack of innovation — Traditional funding options lack the innovation and flexibility needed to meet the unique needs of smaller businesses.
The impact of an increase in borrowing costs
SMBs that manage their resources with strict margins in their budgets are struggling with increased rates. According to the latest Biz2Credit Small Business Lending Index, small business loan approval percentages at big banks slipped again in January, falling from 14.5% in December to 14.4% in the first month of 2023, meaning only 4.78 million businesses were approved. This makes it more challenging to grow and compete in the marketplace.
While this is not good news for banks either, it’s a reality of economics, and banks have more freedom to shift focus onto other opportunities for new revenue. In times of financial crisis or increased inflation, businesses face:
- The increased cost of capital: When borrowing costs increase, SMBs face a higher cost of capital, which can make it difficult and expensive to access financing.
- Reduced profitability: Because they’re unable to access affordable financing, they must cut back on investments or postpone expansion plans, leading to a reduction in profitability.
- Increased debt burden: SMBs likely already have existing debt, and increased borrowing costs will increase the interest expense on their debt, leading to a higher burden. This makes it difficult to meet their debt obligations and leads to financial and operational distress.
- Lower competitiveness: With all of the aforementioned circumstances, small to mid-sized businesses will find it difficult to compete with larger companies that have access to cheaper financing. This can lead to a loss of market share and reduced competitiveness in the marketplace.
Although sound financial advice says to hunker down in tough financial times, pay off debt, save money and not take on loans in a time of increasing interest rates, this strategy is largely reserved for established SMBs, while newer companies are not afforded this luxury. Their potential to survive and thrive depends on having adequate resources to finance new equipment or make repairs, implement enhancements to operations (such as digitalization), and satisfy necessities such as hiring and training employees and paying salaries.
Alternative funding opportunities
Companies who offer alternative funding solutions to SMBs begin with establishing a close and collaborative relationship — understanding the specific financial needs of a company; working to comprehensively understand the business’s industry and competition; providing financial guidance and expertise, staying nimble and creative in their solutions, and providing additional resources or business services including accounting, marketing and legal expertise.
Such lenders offer diverse funding solutions such as invoice funding, streamline payment processes to suppliers, guarantee quick access to funds, and (in qualified cases) transform debt into equity. They also provide supplementary financial resources where the primary lender does not fulfill the total amount desired by the company.
SMBs will find that these alternative solutions often result in lower barriers to entry, making it easier for them to access the funding they need and offering the ability to move quickly and swiftly to take advantage of a growth opportunity or cover an unexpected expense. Additionally, lenders understand the importance of flexible terms, choosing from a variety of repayment schedules or customizing their loan terms to fit their unique needs.
SMBs will also find that alternative financial arrangements breed a deeper understanding of a business’ trajectory. Business owners may feel more confident and comfortable going beyond the traditional loans structured by banks, making alternative funding solutions for SMBs more attractive and advantageous than ever before.
This article originally appeared in The Kansas City Business Journal.