Short-Term Cash Flow Needs: What Solutions Are Available for Your SME?
“My company’s cash flow is tight: what options can I consider?”
A cash flow need can arise without necessarily meaning that the company is in difficulty.
An increase in activity may require the company to finance more purchases or operating expenses before receiving payment for the related sales. A major customer may pay later than expected. Seasonal activity or an exceptional expense may also create a temporary cash flow need.
When this happens, the first reaction is often to look for financing as quickly as possible.
However, before approaching its bank or another financing provider, the company needs to understand why the need has arisen, what its maximum amount is likely to be, and how long it is expected to last. The appropriate response will not be the same for a temporary timing gap as for a cash shortfall that recurs and becomes structural.
Depending on the source of the need, the response may be operational, financial, or a combination of both.
Understand the Source of the Need Before Financing It
A cash flow need does not necessarily mean that the company is unprofitable.
As discussed in a previous article on the difference between profit and cash flow, these two concepts follow different dynamics. A short-term cash flow need may arise, in particular, from the timing gap between cash outflows related to the business and the corresponding cash inflows. The company must then finance that gap until payment is received for those sales.
This is particularly the case when business growth increases the Working Capital Requirement (WCR): the company must fund higher operating cash outflows before receiving the corresponding customer payments. This mechanism is explained in more detail in our article on WCR and business growth.
The need may also result from a significant delay in collections, seasonal activity, an exceptional expense, or longer customer payment terms. It may also reveal a more lasting deterioration in profitability.
Identifying the source of the need helps determine whether the response necessarily has to be financial.
If the pressure on cash results from invoices being issued too late, overdue payments not being followed up sufficiently, excessive inventory levels, or unsuitable payment terms, operational actions may reduce the need.
Financing comes at a cost: interest, commissions, and other related fees ultimately weigh on the company’s profit. Reducing the need through operational actions therefore also helps limit both the amount to be financed and the related cost. Financing can then be used, where necessary, to cover the remaining requirement.
Anticipate and Measure the Need Through Cash Flow Forecasting
By bringing together expected cash inflows and outflows, cash flow forecasts make it possible to visualize how the company’s cash position is expected to evolve, identify periods of pressure early enough, and estimate the financing requirement. When updated regularly, they incorporate changes in the business, such as delayed collections, unexpected expenses, changes in revenue, or inventory levels.
The company can therefore act before the need becomes urgent, implement measures to reduce it, and have sufficient time to arrange financing for the remaining requirement.
This anticipation also facilitates discussions with financial partners. A company that can present the source of its need, the maximum amount expected, its duration, and how it is expected to unwind is better prepared to discuss possible solutions than a company seeking financing at the last minute.
When it comes to cash flow, it is better to anticipate than to react.
Cash flow forecasts are not only useful for knowing the expected bank balance in a few weeks or months. They are a genuine tool for anticipating cash needs, supporting decision-making, and managing the business.
Choose Financing That Matches the Remaining Need
When operational actions are not sufficient to eliminate the need, different short-term financing solutions can be considered.
The appropriate options depend on the company’s situation and may involve different financing partners.
An authorized overdraft or another short-term bank facility can be negotiated with the company’s bank to cover certain temporary timing gaps.
When these initial financing solutions are not sufficient to cover the need, the company can also use all or part of its trade receivables to obtain funds before they fall due, notably through the discounting of bills of exchange, a Dailly receivables assignment, or factoring. Discounting and Dailly assignments are generally arranged through the company’s bank, while factoring may be provided by a bank or a specialized factoring company.
For a highly seasonal business, a seasonal credit facility may also be arranged with the bank to finance the timing gap between expenses incurred and the related future cash inflows.
Shareholders may also, where possible, temporarily provide funds to the company through a shareholder current account.
These solutions are neither interchangeable nor appropriate in every situation. Their cost, any guarantees required, and their implementation conditions must be assessed in light of the company’s circumstances.
Above all, the duration of the financing should remain consistent with the duration of the need it is intended to cover.
A timing gap of a few days should not be financed in the same way as a receivables-related need that recurs with each operating cycle, or the financing of an entire seasonal period.
If the forecasts show that the need continually recurs or does not unwind, it is probably no longer simply a short-term cash flow need. The underlying causes then need to be identified and, where appropriate, a more sustainable financing solution should be considered.
Key Takeaways
✓ A short-term cash flow need does not necessarily mean that the company is in difficulty: it may simply result from a timing gap between cash inflows and outflows.
✓ Before seeking financing, it is important to identify the source of the need and determine whether operational actions can reduce it.
✓ Regularly updated cash flow forecasts help anticipate periods of pressure, assess the maximum amount and duration of the need, and look for a solution before the situation becomes urgent.
✓ Several short-term financing solutions may be available through banks or other financial institutions, depending on the nature and duration of the need.
✓ A need that becomes permanent or recurring should lead the company to investigate its underlying causes and reconsider whether short-term financing remains appropriate.
Afine Conseil supports SME business leaders in managing their company’s financial performance and addressing cash flow and financing challenges.
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