Running an SME can be quite stressful. Nearly every decision can alter the financial success of the company. Not only that, it can often be unclear how improve your finances without harming the future success of your business. Here, we explain 3 relatively simple ways to optimise your small business's finances without jeopardizing your future success.
Optimise Working Capital
Working capital is the amount of money that a business has to cover its short-term operating costs. It is important for businesses of all sizes to have enough cash to pay for short-term financial obligations, such as employee salaries, rent, insurance, or supplies. Businesses can optimise their working capital to impact their cash flow and facilitate their growth.
SMEs that are growing quickly may be short on cash due to their payment cycles. For example, an online fashion brand that does not receive payments from customers immediately but needs to pay suppliers upfront. Even if it were profitable, a rapid rate of growth could easily turn this company into a cash blackhole as it takes on a high level of inventory to match its growth rate, which could make it difficult for the firm to meet its short-term obligations and prevent bankruptcy. To alleviate this problem, some firms may be able to negotiate longer payment cycles for their financial obligations. For instance, they might renegotiate to lengthen their payment terms for supplies. Others may be able to incentivise their customers to pay earlier, through promotions or discounts. These methods could both increase the firms' cash flow and allow them to more easily meet short-term obligations.
However, not all businesses (particularly SMEs) have the bargaining power to negotiate better payment terms with their customers or their suppliers. In this case, companies can apply for working capital loans as an alternative. These short-term loans are specifically designed for businesses to finance their daily operations, without the burden of long-term indebtedness associated with a business term loan. They also allow businesses to meet short-term obligations, and allow firms with slightly more cash to invest more money into growing their business.
For example, invoice financing is a type of working capital loan that allows businesses to borrow based on goods or services that they've already provided for customers. This type of financing can be beneficial for growing companies that have plenty of work lined up, but need cash to fund their day-to-day costs like buying additional inventory or hiring employees to match rapid growth of demand from their customers.
Cut Costs with Free Energy Efficiency Measures
Energy efficiency measures are a way for SMEs to substantially reduce their costs. Estimates indicate that 30% of energy costs in commercial buildings comes from waste through inefficiencies. Simple and free measures can significantly cut your business's utility bill, consequently improving your company's bottom line.
First, setting computers to automatically enter "sleep mode" after a period of inactivity can save up to S$65 per computer annually. Additionally, you can cut lighting expenses by 10 - 40% by turning off lights while your SME is closed or when natural daylight is sufficient. Finally, it is important to keep air vents unblocked, as this can require 25% more energy for distribution. None of these techniques will completely transform your financials; however, they can easily add up to thousands of dollars of savings over time that you can divert to other business costs, such as office supplies or a year-end office party.
Use Debt to Purchase Required Equipment
If your business requires equipment to increase its production, you should consider taking a loan to purchase the asset. There are two reasons that this may be cheaper than purchasing the asset with your own cash.
First, interest rates are currently very low. If you expect to earn a greater return greater than the cost of borrowing, then you can magnify your returns on your asset. This is called leveraged financing. For example, you need to purchase an equipment, which costs S$10,000, to increase production. You expect that this equipment will yield S$1,000 of income per year, translating to an annual return of 10% on your investment. Instead of paying the whole S$10,000 with your own money, however, paying with S$2,000 of your own cash and S$8,000 obtained through a loan could increase on your capital to 50%.
Additionally, interest payments are tax deductible. This means that you can cut your tax bill by paying for equipment using debt compared to paying with your own money. Put differently, this implies that the government is helping you pay for your asset financing by partly offsetting your interest payment with reduced tax expenditure. However, it is important to remember that if your actual returns are lower than your interest rate, you losses will also be magnified. This makes leverage a risky, while potentially very beneficial, financing technique.