How Finance Leaders Should Prepare for a Credit Crunch

In light of recent turmoil in the banking industry, financial experts warn that a credit crunch may be on the horizon. The recent series of bank failures has sounded alarm bells for most financial institutions, especially as new research shows that 186 more banks will fail if even half of their uninsured depositors decide to withdraw their funds. Market experts are now predicting that most small-and-medium-sized banks will soon tighten their credit conditions, prompting a credit crunch across the country.

This would have serious repercussions for small businesses, which often face more difficulty securing the funding they need to survive and thrive, compared to larger firms that have ample assets and resources to leverage in times of trouble. Regardless of company size, CFOs who are looking to weather this credit crunch should start preparing now to reduce their business impact.

In this article, we’ll dive into what a credit crunch is, explore its root causes, and explain why financial experts in both the public and private sectors predict a credit crunch is looming. We’ll also share what potential implications a credit crunch has on businesses and, most importantly, provide practical advice on how CFOs should prepare their organizations to stay ahead.

What is a credit crunch?

A credit crunch (also known as a credit squeeze or credit crisis) is a sudden reduction in the availability of loans. It generally leads to stricter lending practices and makes it harder for businesses to obtain financing even if they are otherwise financially sound. This creates significant challenges for businesses, including less access to capital and higher interest rates on loans, both of which severely limit firms' ability to invest in growth.

A credit crunch also often spells cash flow issues for firms, particularly small-to-medium-sized organizations that rely heavily on credit to fund their operations. According to the 2019 Small Business Credit Survey, at least 70% of small businesses have some amount of outstanding debt, with an average amount of $195k.

What causes a credit crunch?

A credit crunch occurs when there is a shortage of funds in the credit market, making it more difficult for borrowers to get loans. This can happen when lenders have a limited amount of funds to give out, are unwilling to lend more money, or have raised the borrowing cost to a level that most borrowers cannot afford. A credit crunch is usually caused by a combination of factors, including decreased consumer demand for goods and services, increased uncertainty about future economic conditions, and financial regulatory issues.

Why do experts predict a credit crunch after the recent bank failures?

The recent failure of SVB, First Republic, and other banks, prompted many depositors to move their funds out from smaller banks in favor of banking giants like Wells Fargo and JP Morgan Chase. With less money in their hands, many small and medium-sized lenders will soon resort to adopting stricter lending practices, which in turn will trigger a credit crunch. It's important to note that this decision will disproportionately affect small businesses, who receive almost 70% of their loans from banks with less than $250 billion in assets.

How does a credit crunch impact businesses? 

The primary implication of a credit crunch is that it makes loans more expensive, or, in some cases, completely unavailable for businesses. Limited access to loans (and higher interest rates on those that are available) creates challenges for businesses trying to maintain their working capital and cash flow. This can lead to significant financial hardship, even for otherwise successful firms.

Businesses that rely heavily on customers' credit facilities will be in trouble since their customers may also face the same problems of securing credit, which can lead to payment delays and late settlement of accounts. As a result, firms may have to limit their operations and even lay off workers to stay afloat. This creates a ripple effect across the economy as other businesses suffer from decreased sales and profits due to reduced demand.

For small-to-medium-sized businesses, the impact of a credit crunch can be even more severe. Tightened lending can lead to difficulties managing inventory, paying wages, and meeting other financial obligations. Lenders also tend to favor large and established firms with a proven track record of repaying loans promptly whereas small businesses with limited trading histories and lower credit ratings often find it harder to secure funds.

How can CFOs prepare for a credit crunch? 

CFOs must optimize their working capital to weather the credit crunch storm. To do so, they must prioritize cash management over profit maximization, assess their business operations to determine any cash drains and create contingency plans to manage cash flow. These optimizations can mean the difference between survival and collapse, especially during a downturn.

Below are 6 detailed tips for how your team should optimize your capital ahead of a credit crunch:

  1. Conduct a thorough review of your cash flow. As a CFO, it's crucial to stay on top of your company's cash flow to ensure financial stability and growth. Conducting a thorough cash flow review involves analyzing both accounts receivable and accounts payable. Start by examining all incoming payments and identifying any delays or discrepancies. Then, review all outgoing payments and identify opportunities to save costs or delay payments. It's also crucial to track and prioritize payments to avoid any cash flow gaps. While it's a tedious process, this comprehensive understanding of your cash is crucial to surviving a credit crunch. You can streamline this process by partnering with an all-in-one cash management solution like Centime to unlock 360-degree views across AR, AP, and all your accounts to instantly predict cash flow.
  2. Secure a working line of capital credit now. This ensures your business has access to emergency funds in case of cash flow problems or limited access to traditional financing options down the line. When securing a working line of credit, you must first decide between using a bank or a financial services provider. Historically, firms have been frustrated with the extended application and approval timelines from banks. While digital lenders offer quicker application reviews, their loans come with a steep price tag. Today, Centime Credit Line is disrupting this traditional market by bridging the two models and offering the best of both worlds: simple applications; faster decisions; cost-effective rates; and flexible payment terms.
  3. Automate accounts payable to take control of cash outflows. If you're still manually cutting checks, or not paying attention to payment discounts and penalties, now is the time to consider automating your accounts payable workflow. An automated AP solution like Centime can help you streamline payment processes, reduce human error and duplicate payments, and increase operational efficiency to cut AP costs. Automating AP can also help you take advantage of early payment discounts with vendors and avoid late payment penalties, thereby strengthening your strategic supplier relationships and increasing your cash reserves.
  4. Streamline accounts receivable to optimize cash inflows. Automating accounts receivable involves using software to speed up the collection process and reduce errors in invoicing and payment. This ensures your business receives payments faster, which in turn improves your cash flow and strengthens your financial standing. Teams are increasingly turning to AR automation software like Centime to streamline their payment processes for customers and optimize cash flow.
  5. Plan for uncertain scenarios with a cash flow forecasting tool. In a credit crunch, cash flow forecasting is the essential tool to monitor and manage your company’s liquidity. It’s essential to have a reliable cash flow forecast to make informed decisions. With an all-in-one cash flow forecasting solution like Centime, you can plan for multiple scenarios and take proactive steps to secure additional capital before a crisis happens.
  6. Put together a contingency plan. Assess what happens if sales fall, if suppliers go bust, and if staffing costs increase. Reassess your cash flow forecasts and consider the options available to you. If necessary, review inventory levels, reduce costs (where possible), and negotiate longer payment terms with creditors. By taking the right steps now to create a contingency plan, CFOs can ensure their business is ready for any financial turbulence that lies ahead. Centime’s all-in-one cash management solution provides access to real-time insights and forecasts to help you prepare for a credit crunch.

What tools do finance teams need for a credit crunch?

The right tools can make or break a finance team. Here are common systems and resources that modern finance teams use to streamline operations and manage their cash flow:

  • ERP System: An enterprise planning (ERP) system is an integrated software that automates and streamlines business processes, including accounting, inventory management, customer relationship management (CRM), and more. As the system of record for finance teams, an ERP is the foundation of any modern finance tech stack.
  • AR Automation: An automated accounts receivable solution digitizes the AR workflow, eliminating manual tasks and optimizing efficiencies every step of the way. With an automated AR solution, you can help your customers pay you faster and optimize cash in-flows.
  • AP Automation: Teams are increasingly turning to accounts payables (AP) automation tools to streamline their invoice payment processes and eliminate errors in their payment workflow. Automating your AP helps you optimize your company’s cash flow while also reducing the risk of late or duplicate payments.
  • Cash Flow Forecasting Tool: A cash flow forecasting tool helps you build a comprehensive view of your company’s current and future financial health. It visualizes different financial scenarios and provides clear insights into your cash flow, so you can make informed business decisions whether you're scaling for growth or looking to ensure stability during economic uncertainty.

Centime is the only AP, AR, and Cash Management solution that syncs with your ERP and offers a fully integrated working capital line of credit. By unifying AR and AP into a single system, Centime helps finance teams eliminate silos and unlock a clear, comprehensive view of their cash flow. We also offer a short-term working capital line of credit to help you quickly access cash and make sure you have enough money to pay for things your business needs right away.

Centime is a powerful suite of cash management applications. Meet with one of our experts to learn more about automating AP and AR, and accelerating your cash flow

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Weathering the Storm

A credit crunch can have severe consequences for small to medium-sized businesses. CFOs must prepare for the worst-case scenario by conducting a thorough review of their current financial position, devising a cash flow forecast, and putting the right financial tools in place to support their team.

By securing a line of credit now, optimizing working capital, and creating a comprehensive view of your cash forecast, CFOs can prepare for the inevitable crash and ensure their businesses survive and thrive - no matter the circumstances.

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