The crisis in the credit markets created some new American superheroes. Former Fed Chairman Ben Bernanke and Treasury Secretary Timothy Geithner are fondly recalled as a dynamic duo who engaged the titanic struggle with the evil forces of inflation, stagflation, a weak dollar and dysfunctional credit markets. Their mission was is to keep the specter of a depression at bay. By all accounts they succeeded. For the time being.
Their weapon of choice was high octane capital swaps (Quantitative Easing I & II), a low interest generator and paper guarantee machine. The machine produces accelerated capital flows that pumped liquidity into credit channels faster than water surging over the Hoover Dam at the height of a Rocky Mountain snow melt.
Just as the great Colorado River brings life and growth to the parched deserts of the American southwest so to is liquidity the essential condition to sustain the economic viability of a corporate enterprise.
Liquidity concerns grow particularly close to the bone of small businesses (SME). Liquidity is their bread of life and SME must master the fine art of liquidity management. Unlike large corporations and governments, the ability of small businesses to print money, tap commercial paper markets, leverage or sell assets or engage in other forms of exotic balance sheet alchemy is limited. So at the end of the day, when the payroll is due, a key supplier is waiting by the receptionist for a check and your best sales person is doing her best to close that huge new deal your anxiety grows a bit as you ponder your cash position and begin to project the next three months.
You call your local banker. You are a long standing and valued customer but “risk aversion” continues to creep into the discussion and they tell you that their funding sources have grown “risk averse” due to losses in the sub-prime mortgage market and finding new funding sources have been difficult. So for now at least the expansion of a credit facility with them is not an option.
You keep getting calls from those merchant finance companies that are offering short term loans but the prospect of paying usurious rates of 18%-30% on future credit card receivables will put a major dent in your profit margins. That makes this credit channel’s cost of operating capital prohibitively expensive.
That’s where risk management comes in. Many small business owners are masters at risk management. They are skilled entrepreneurs that put personal capital at risk. They got major skin into the game and that motivates them to continually evaluate how to protect their assets and maximize returns. Many small business owners are extremely gifted at leveraging assets to address opportunities. Assets such as economic capital, people, intellectual capital, suppliers, facilities and products are routinely utilized to enhance and extend liquidity. But as credit markets tighten all small businesses need to become more aware of preserving liquidity. This can be accomplished by incorporating a few simple risk management practices.
A good place to start is to make sure your systems and business processes are optimized to support efficiency. Many of the traditional cash management techniques are well known. Small business accounting software and the availability of internet banking tools are a great help to small businesses. These tools help to extend and manage payment cycles, match assets to liabilities and a good banker will help you develop specific strategies and practices to address these issues and improve your cash position.
Another area to consider is to arbitrage credit providers. Obviously this tactic works great during times of enhanced liquidity but credit channels are still vibrant and the market is crowed with numerous providers and products. Though it is true that as more participants enter markets they tend to become more efficient resulting in small spreads the volatility of the credit markets can work to your advantage. If you can replace a line of merchant finance credit with a bank offered facility you will increase your margins by the spread of the savings.
Sources of capital leakage from the company are a major threat to liquidity. Small business managers must be aware of how to assess this risk factor and how to minimize potential damage it can cause. By “leakage” of enterprise capital we mean to suggest that capital invested by the business did not create an acceptable rate of return. A concerted approach to assessing and managing risk factors preserves liquidity, builds equity and a strong balance sheet.
The principal villains that contribute to capital leakage are poor cash management and inappropriate, non-prioritized or misdirected capital allocation initiatives. These initiatives are acquisitions or projects requiring the investment of time, money, personal energy and corporate resource that do not produce an acceptable rate of return.
Small businesses need to incorporate opportunity cost in determining ROI on business initiatives. This is because a small business must limit the number of projects it can engage. It must be certain that current projects will build greater value for the business then the project it declined to pursue. An understanding of value at risk (VaR) is also a useful metric to determine what initiative or project will mitigate the greatest risk and produce the greatest return on capital expenditures.
Risk assessment is a powerful opportunity discovery exercise that requires intentionality and discipline. Many small business owners do these assessments in their head and make decisions based on gut feeling or intuition. An opportunity discovery methodology that walks you through an objective assessment of risk factors is a wonderful complement to the fine tuned business instinct of the small business owner.
Lastly, small businesses need to focus on their most profitable products, best clients and key suppliers within their most promising markets. This may seem obvious but many businesses are reluctant to alter their business models to accommodate this blatant reality. Inertia, culture and ego are the principle culprits and ironically clients, products, suppliers and markets pose some of the greatest risks to small businesses.
It is true that a rising tide lifts all boats. We have just experienced one of the greatest economic expansions in the history of the global economy. It’s been a great run. But the party is over. The era of an unending flow of easy credit and cheap capital is over for now. Until happy days return again we must adapt and protect our solvency through effective liquidity management practices. During times of economic uncertainty and distress it’s a great opportunity to build financial health through effective risk management because when the tide goes out the rudderless businesses captained by poor stewards will crash upon the rocks and get beached on unforeseen shoals or sink into the depths of the unforgiving briny deep.
Get liquid and stay liquid with CreditRedi.
How can I tell you what is in my heart?
How can I measure each and every part?
How can I tell you how much I love you?
How can I measure just how much I do?
How much do I love you?
I'll tell you no lie
How deep is the ocean?
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How many times a day do I think of you?
How many roses are sprinkled with dew?
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To be where you are?
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From here to a star?
And if I ever lost you
How much would I cry?
How deep is the ocean?
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