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As governments across Europe turn to increasing interest rates to control inflation, many SMEs are struggling to keep their heads above water. In an attempt to help, SME Bank offers some potentially crucial advice.

Virginijus Doveika is the CEO of SME Bank, a Lithuanian neobank catering to small and medium-sized enterprises (SMEs). Here, he explains how SMEs can survive amidst difficult macroeconomic conditions and ‘credit squeeze’.

Governments across Europe are attempting to control inflation, and higher interest rates are their preferred tool. It’s less politically damaging than tax rises. 

This is the classic ‘credit squeeze’, where money is squeezed out of the system to discourage things like price increases and pay rises.

That’s the track we are on in Europe, and elsewhere across the globe. With base rates in the Eurozone at 4.25 per cent (they were 0.0 per cent as recently as September 2019), there is naturally concern about what will happen next. 

SMEs in a credit squeeze

History suggests that squeezes hurt and that business is in for a tough time. The effect on SMEs is likely to be especially acute. Over four years after the 2007/08 start of the banking crisis, a survey from the UK’s Federation of Small Businesses found that four in 10 small firms had been refused credit. 

And studies, including by the OECD, confirm that credit squeezes affect SMEs more than larger companies.

Why? SMEs are more dependent on bank financing than larger companies, which can access capital markets, trade credit, or internal funds. SMEs are also more vulnerable to changes in credit conditions, such as higher interest rates, stricter collateral requirements, or shorter maturities, because they have less bargaining power, lower credit ratings, and fewer assets to pledge as collateral. 

Faced with these headwinds, it’s no surprise that a new report from the UK’s Centre for Economics and Business Research (CEBR) predicts that rising interest rates will cause 7,000 SMEs to cease trading every quarter in 2024.

Silver linings? 

It’s not all doom and gloom, however. Those same studies also indicate positive impacts of a squeeze on the composition and quality of the SME sector. Tough conditions favour more productive and financially sound firms over less efficient and more leveraged ones.

In this sense, squeezes are a Darwinian struggle from which the strong emerge, ready to prosper in the next up-cycle.

6 things SMEs should be doing now to ensure they are long-term winners

There’s no point in going into denial about the squeeze. It’s here, and SMEs need to find ways to adapt and thrive, despite the pressures. 

• The first thing to do is monitor cash flow and budgets. Vigilance and visibility are vital in a credit squeeze. Keep an eagle eye on cash flow and budgets using online accounting tools linked to your bank account. Real-time data allows early identification of potential shortfalls or gaps. This enables rapid adjustments and agile responses, essential when the economic climate is deteriorating. With financial oversight and control through cloud-based systems, you can spot problems arising and make prudent decisions to strengthen the business. Forewarned means forearmed in the battle for survival.
• Seek alternative sources of funding. With banks tightening lending, cast your funding net wider. Tap into alternative sources beyond traditional loans. Supply chain finance, peer-to-peer lending, crowdfunding and invoice discounting can inject vital cash flow. Seek out government grants, subsidies and tax breaks specifically aimed at SMEs. If you have ambitious growth plans, private equity could provide a capital injection. Collaboration with other businesses may reveal complementary strengths you can leverage. Thinking broadly about financing creates resilience. Don’t rely solely on banks – be creative in finding the funds you need not just to survive but thrive.
• Negotiate with suppliers and customers. Strong negotiation skills can ease cash flow strains. Press suppliers for extended payment terms, bulk order discounts or other benefits. Dangle the carrot of continued loyalty and future growth. On the flip side, entice customers to pay faster with incentives like discounts or extra services. Shorten the gap between outgoing and incoming funds through astute deal-making. But aim for win-win arrangements, so relationships stay strong when conditions improve. With improved cash conversion cycles and diligent credit control, you can keep working capital flowing and bad debts minimal. Play the negotiation game artfully.
• Focus on value-added activities. When credit tightens, you must double down on value-added activities. That means making hard choices to focus top execs exclusively on the unique capabilities that drive your competitive advantage. Your strengths that customers can’t get elsewhere must be protected and nurtured. Delegate or outsource everything else. Reward and recognize work that sharpens your edge and align incentives to reward and recognize activities driving growth and innovation. Stay disciplined amid the storm. With clear priorities and a lean structure, you can weather turbulence better than rivals who inflate costs trying to prop up non-essential operations. 
• Innovate and adapt. SMEs need to respond to changing market conditions and customer needs by looking for opportunities to create new products or services or to enter new markets or segments. Challenge assumptions, pivot to capture new opportunities and get ahead of emerging customer needs. Experiment with new business models, products or services; prototype rapidly. One way to approach this is to embrace digital transformation and adopt new technologies that can enhance efficiency, productivity, and customer experience. Other approaches are to collaborate with partners to accelerate development and empower people to improve processes by fostering agility and creativity. 
• Use remote working to your advantage. Innovation in work arrangements can reduce costs while keeping talent. Offer sabbaticals, remote working or flexible hours to retain skills while controlling overheads. Reduce payroll by buying in expertise as needed. Energise people through workplace autonomy and mastery of new skills. Set clear output targets, then give people flexibility on how they achieve them. Maintain and deepen connection through regular check-ins and digital collaboration tools. A motivated team beats an expensive team – foster engagement on a tight budget.

None of this will be easy. However, a credit squeeze brings challenges but also possibilities. With prudence, agility and imagination, it can be navigated successfully. Employ these six strategies to control costs, create value and foster motivation, emerging leaner and more focused when conditions improve.