We are into an exciting New Year but one fraught with risk.

Our economy, shown by the recent GDP figures, is marginally contracting and we might be facing a double dip recession although the Government are forecasting very modest growth this year.

The crisis in the Eurozone rumbles on and if this is not sorted out we face the very real risk of another credit crunch. We might be comforted that our banks are not as exposed as others on the European mainland but should a European bank fail then we will not be immune from the fallout. Europe would be plunged into recession and this would damage us all.

On the brighter side we have the Queen’s Diamond Jubilee celebration and the Olympics and I believe that these will give a boost to moral and encourage growth here in the UK so let’s not be too gloomy!

Whatever side of the coin you look at there is no denying this year is likely to very volatile. For the business owner this is very challenging when making plans for the future.

But some key steps can make all the difference:

1. Budgets need to be very closely reviewed and flexibility is crucial. Don’t be afraid to revise your budget during the year to take account of changes in demand. Monitor actual performance against your budget on at least a monthly basis and don’t just look at income. Make sure you are maintaining your margins especially gross and operating profit.
2. Keep extremely tight control over overheads.
3. If you purchase new assets make sure that the potential return warrants the investment.
4. Credit control is crucial! Make sure that your credit procedures are watertight. Chase up outstanding debtors at a very early stage. You want to be at the front of the queue if things are going wrong. Send invoices at the same time as delivery of your goods or services. Don’t wait ‘for the end of the month’ to send out your invoices.
5. Thoroughly check out the creditworthiness of new clients.
6. Keep cash flow under constant review. Perversely there tends to be more business failures as the economy comes out of recession. The reason? Answer; lack of cash to finance a growing order book! Traditionally your bank would help out with an overdraft but the banks are much more conservative now so if you see a need on the horizon speak to you bank at an early stage.
7. Ensure your managers have the skills to really understand how to analyse figures and business plan accordingly. Without a financial background this can be daunting for many and some guidance can really help.

So, let us all keep our fingers crossed and with proper planning and control I wish everyone an exciting, happy and prosperous New Year.

I thought that I would share my thoughts on a subject which is making headline news as I write.

The debate is around the breakup of the banks to protect the retail depositor from the high risk activities of investment banking, sometimes referred to as ‘Casino Banking’, which implies reckless gambling with our money. There appears to be serious tensions at Cabinet level within our Coalition Government and it will be interesting to see who gets their way!

Emotions can often cloud our judgement, so let’s take an objective look at one of the issues.

A key function in investment banking is the use of derivatives. These are financial instruments that are priced based on the future value of an underlying asset. Let me give an example.

Let’s say that you want to build a Villa in Spain (most unlikely at the moment!) and that this is going to cost you half a million Euros over the next six months. Assuming that you have to buy these Euros with sterling, it’s not rocket science to realise that you run a currency risk should the Euro appreciate against sterling. So what can you do?

1. If you can afford it, buy the Euros now and deposit them in a Euro
interest bearing account and earn some interest until they are needed.
2. Persuade the Spanish builder that you will pay in Sterling (which is
probably not feasible.)
3. Look to ‘insure’ against the possible rise in the value of the Euro
against sterling.

Three looks attractive so, you could enter into a contract now with a bank to sell you the Euros later when you need them, but at an exchange rate that is agreed now. This is called a forward exchange contract and it is a very simple type of derivative.

This transaction is a classic case of using a derivative to hedge against risk. But what about the situation where you aren’t buying a villa at all? Could you still enter into this derivative transaction and, if yes, why?

The answer is “yes” for the reason that you want to gamble on the future value of the Euro against sterling. In simple terms you sell the Euros later for a profit, but you run the very real risk of losing money.

So, derivatives can been used to hedge risk and speculate (or gamble). The “villa” is a very simple example, but if you can imagine a world of very complex derivatives being traded often using borrowed money for speculation, then you can begin to understand where the terms ‘Casino Banking’ comes from!

My own view is that there is merit in the argument that there is far too much speculation in derivatives, often by Hedge Funds, and although it is unrealistic to expect such practices to cease, I do think that their use should be curbed by, if necessary, Government action. It will be interesting to hear the views of others!  

I’m sure many of us are enjoying the early summer weather and looking forward to balmy days ahead but there are storm clouds on the horizon.

I’m not talking about the weather, but more about the state of the European economies which could have an impact on all of us.

As I speak these storm clouds are gathering over the Eurozone with rating agencies threatening to downgrade several European countries debt. Italy is the latest country to come under the spotlight and although it is unlikely to default on its sovereign debt the parlous state of its finances with little or no growth coupled with political paralysis must raise serious concerns in the medium to long term.

So what started with Greece has now spread to Ireland, Portugal and Italy and, dare I say, Spain and Belgium are now on the radar. At the same time we have the spectre of rising inflation hovering over us.
 
Why does this matter to a smaller UK business merrily making its way in the world?

Well it does matter. A default on debt by a country could have catastrophic consequences for its creditors, who may include UK financial institutions. We could have another banking crisis just as in 2008. This could plunge us back into recession and start another round of bailouts and result in profound consequences for the UK.  Basically does the UK government have the financial capacity to repeat the bailouts of 2008?

This all seems very pessimistic and perhaps I am painting a grim picture, but we should be prepared.

In my opinion business owners should:

a. Hedge against currency exposure especially if they have clients in the Eurozone.
b. Plan to mitigate against the effect of higher interest rates should inflation pressures result in a rise in interest rates.
c. Plan for the impact on profits and cash flow resulting from a reduction in turnover.
d.  Pay very close attention to cost control.
e. Be extra vigilant with their credit control.

And finally remember:

- Don’t borrow more than you can afford
- Don’t simply substitute today’s loan with a loan from someone else; after all it has to be repaid eventually!
- Wealth creation is the key to repaying debt.