The overdraft. The old financing friend of the small business. Provided by the banks to meet short term monthly or seasonal swings in cashflow or in some cases inappropriately used to purchase assets for the longer term. Often unsecured and historically reasonably priced, no wonder it has over the years been a popular form of finance for small and medium sized businesses.

However, it is now clear that, due to changes in the global banking industry, this form of flexible bank financing could become a thing of the past. This old friend could in future become a real burden and business owners should start to plan to avoid some of the more painful consequences.

Changes to bank regulations including Basle 3 and, in the UK specifically., the proposals of the Vickers Commission are being developed which are designed to prevent a repeat of some of the bank failures seen in recent years. However these are beginning to have inadvertent consequences in the real economy. Banks are having to hold more cash and given this is a more expensive source of finance for them they are having to shrink to survive. This is creating a possible gap between what they can provide and what UK business needs (up to £191 billion by 2014 according to one report).  Allied to all of this is the squeeze being put on the banks by the ever deepening crisis in the Eurozone. The likelihood is that either costs to borrowers will rise or the availability of credit will have to fall (or a bit of both).

And worst, under the new regulations the banks will no longer distinguish between facilities being used and those that have been made available but are not used; they have to retain cash just in case that overdraft is called upon by the business owner. So, the banks are most likely to make overdrafts more expensive, or withdraw them and make the business owner take out a loan instead with the permanent cost that this entails.

Who will this affect the most? The small business owner, who relies heavily on unsecured lending, facilities as distinct from the larger players with better credit ratings.

So what action should you, the business owner, take when faced with your own potential credit crunch? The following would be a good start:

• Plan for the future (at least 12 months forward) in particular have a budget for capex (capital expenditure) so that you know when replacement vehicles and machinery may be required before they reach the end of their useful life
• Track large payment obligations particularly VAT and corporation tax on a monthly basis so that they don’t come as a surprise when due.
• Make sure you have adequate access to alternative forms of financing even if you don’t need them now (e.g. HP, leasing, invoice discounting, family money, grants etc)
• Where the facility exists spread your bills through the year by paying by standing order. This also makes the budgeting process easier.
• Reduce reliance on single large customers particularly where these might have the whip hand when it comes to negotiating payment terms with you
• Avoid the temptation of ‘the big sale’ particularly if at lower margins unless you have fully assessed the implication on your cash flow.

Finally we recognise that it may be impossible to remove reliance on bank finance in its various forms. In a later article we will discuss how to secure the most advantageous financing by presenting our business in the best possible light and managing your bank relationship.