Without easy access to borrowing, many companies will decide to lay off staff, cease recruitment or reduce pay awards.
The consequent reduction in disposable incomes reduces retail spending and affects economic growth. But Government schemes exist aimed at addressing this.
The availability of credit can be crucial to an organisation, especially in the early years or where the organisation is seeking to expand, recruit or carry out important research. Any reduction in the availability of credit can adversely affect an organisation’s cashflow.
Just like a private individual, an organisation seeking finance will have their credit worthiness assessed by a potential lender. Credit worthiness may be assessed using evidence from many sources, such as:
- Media reports about the organisation
- Data obtained from suppliers and other parties the organisation works with
- The organisation’s financial statements
- The organisation’s track record in meeting previous loan obligations
Banks can be reluctant to lend to smaller organisations; these are seen as high risk loans as so many smaller organisations fail. The lack of adequate security is a common reason why a business loan application may be unsuccessful. The recent credit crunch has only made banks less willing to lend to organisations, or to increase their overdraft limits, and the credit squeeze has also made it harder for business owners to obtain personal loans and increased credit card limits.
A Bank of England report in October 2011 revealed that the average interest rate being paid by businesses was 4.68%, well in excess of the Bank’s base interest rate. The report also stated that lending to businesses with turnover below GBP 25 million had fallen by 5.1% in the previous 12 months.
The economic effects of a business credit crunch
If an organisation is experiencing difficulties with cashflow, it may respond by cutting staff, or at least by ceasing to recruit new staff. Unemployment rates then rise dramatically. An organisation may also choose to address its financial difficulties by freezing pay increases, or granting increases that are well below inflation.
Unfortunately the above scenarios result in reduced levels of disposable income for large numbers of people. This means that people cut back on their retail spending and buy fewer goods and services from businesses, thus increasing organisations’ woes further and creating something of a vicious circle.
In response to the adverse effect this is having on economic growth, the United Kingdom government has set targets for the banks to meet regarding the amount lent to small and medium-sized enterprises.
In order to encourage the banks to lend, the government has at various times operated initiatives such as the Small Firms Loan Guarantee Scheme and the Enterprise Finance Guarantee (EFG) Scheme. The latest incentive was the National Loan Guarantee Scheme announced in the 2011 Autumn Statement, where it was confirmed that the government will underwrite GBP 40 billion of low-interest loans to companies with annual turnover of less than GBP 50 million, in what has been described as a credit easing scheme. In the same statement, it was revealed that the EFG Scheme was being extended to cover organisations with turnover up to GBP 44 million.
Other possible solutions
Other solutions may involve more careful cashflow forecasting, and seeking out other forms of business finance such as invoice finance.