Financial contagion and the impact on UK SMEs.

With the Eurozone again entering crisis due to the Spanish debt and the growing skepticism over the country’s ability to escape a bailout, uncertainty over the fate of the single currency and financial contagion between countries continues to impact the confidence of markets and businesses worldwide.

However, contagion is not confined to Eurozone countries. It’s also a phenomenon being experienced by businesses in the UK - especially SMEs. At a time when purchasers are pushing payment periods out to 45 days, 60 days or longer, the impact on a supplier’s cash flow can mean they have to defer or default on their own payments, creating contagion, or the risk of going into an unrecoverable decline.

Tightening credit lines

Whilst the term ‘credit crunch’ has dated rapidly, the notion is still very much a reality for UK businesses. Bank of England figures show that lending has fallen every quarter for the last three years.

In this environment, many big businesses are seeking to secure their own finances against economic uncertainty and ever- tightening credit lines by adapting their financial policies. Independent research commissioned by us showed that 45 per cent of UK FDs said that they would be more likely to lengthen terms for supplier payments in 2012 than they were 12 months ago.

The domino effect

As many experienced during the early years of recession, 2012 may see a number of big businesses using their purchasing power to push out payment terms and demand early repayment discounts.

Forced renegotiation of payment dates and terms can have a serious knock-on effect on the financial health of British SMBs. Small businesses that supply large enterprises do not have the cash buffer nor the buying power to spread the impact amongst their own suppliers and, as such when their cash flow is put under strain from forced terms, some can fold under the pressure.

Businesses engaging in B2B commerce are inextricably linked to each other’s success. As business pass on the impact of late payment or even fold under pressure there are serious knock-on effects for the companies they do business with. Lost business, damaged relationships, smaller supplier base and less competition, the results of financial contagion make everybody poorer.

Solutions

Some small businesses rely on credit facilities, such as overdrafts, to provide temporary liquidity but, as banks prove increasingly reluctant to part with funds, smaller businesses are put under pressure to manage their cash more effectively.

SMEs cannot draw upon support from the banking industry to cope with the pressure that renegotiated payment terms may cause. Government policy exerting pressure on late payers is in the offing but little can be done about those using their purchasing power to force renegotiation.

What SMEs can do is ensure they review new buyers’ and suppliers’ track records before doing business, ensuring they go in to any deal with their eyes wide open. Ensuring their own cash management systems are tightly controlled will help finance managers keep abreast of the situation, assessing their cash flow and responding according to the most up-to-date information about income and outgoings.

Our research revealed that 62% of UK CFOs and Financial Directors believe that their accounts payable is compromised because they don’t have enough visibility of cash flow. The reason for this is that 83% of customer invoicing payment systems and 84% of supplier payment systems are not optimised.

Companies of all sizes need to ensure their financial systems are assisting rather than compromising the companies’ financial position. Whilst some delays are calculated financial strategy, many are the result of lethargic or error-prone systems and heavy manual admin. Speeding these processes, by automating invoice processing, for example, results in reduced costs, faster payments and far more transparency around the cash flowing in and out of the business.

Cash-flow contagion has serious consequences for businesses of all sizes but SMEs in particular need to ensure they can respond quickly and effectively to external financial pressure. Accurate and timely information is the first step to building financial strategy on fact rather than faith.