Realistically, we all knew that the financial aftershocks of COVID-19 would be felt long after the pandemic itself was brought under some kind of control.
And so it is that we find ourselves teetering on the edge of recession – inflation at a 40-year high of 9%, interest rates hitting 1% for the first time since the end of the the Noughties, a steady downward slide in retail sales volumes.
These are unchartered waters for entire generations of consumers, homeowners and business leaders.
Of biggest immediate concern, of course, is high inflation and what that is doing to both household budgets and business costs. Soaring energy, fuel and food bills will keep driving down consumer spend as people find they have less spare cash in their pocket, meaning businesses in many sectors will see their revenues dwindle.
But at the same time, businesses are facing rising costs of their own. Being hit by both ends at once – rising costs and falling revenues – is not a pretty prospect for anyone in business.
Firms have various options to help them ride out turbulent economic times. They can look at cutting costs or passing on price increases to customers. They can look for new revenue streams. They can double down on providing exceptional service to existing customers to maximise their chances of retaining them.
But arguably one of the most important strategies in difficult times is making sure you have a cash buffer – a reserve of funds to draw on so you can keep paying your bills if you do experience a dip in revenue.
A safety net against insolvency
Let’s not forget that insolvency, the precursor to business failure, is the inability to pay off your debts as a business. It doesn’t take much of a blip in your cash flow to find yourself insolvent. The next thing you know, your creditors – who have their own financial struggles to deal with – are applying through the courts to have you pushed into administration or wound up.
A cash buffer is a safety net against insolvency. Conventional wisdom says that businesses need a minimum of three to six months’ worth of cash in reserve – calculated as total operating expenses required in that time period – to have a ‘safe’ buffer.
But it is also well known that many firms, especially SMEs, keep nowhere near that amount of cash in reserve. One study in the US by JP Morgan found that the average number of ‘cash buffer days’ held by small businesses was just 27, with a quarter of SMEs having the equivalent of just 13 days’ worth of expenditure held in the bank.
That’s the business equivalent of living hand to mouth, and when times are tough in the wider economy, these are the businesses that are at greatest risk of going under.
As business costs rise, so does the risk of insolvency, simply because companies are having to find more ready cash to service their debts. That makes having an adequate cash buffer even more important.
In a future blog, we will look at how you can increase the cash buffer your business holds to offer better protection as costs continue to rise.