Understanding How Financing Impacts Your Business

SMEs face many challenges when it comes to financing and are often unable to obtain optimal financing for their business needs. Before applying for financing, SMEs need to identify which of the 3 broad categories they fall under:

Start-ups (Established for less than 1 year)

  • A large number of SMEs fall under this category

  • Banks do not finance due to lack of credit history

  • Alternative forms of financing exist but at higher rates

1 – 3 years old

  • Able to obtain certain unsecured loans with capped quantum

  • Guarantor/s’ credit bureau status affects success of application

  • Need to have clean credit history with healthy bank deposits / balances

3 years and above

  • Clean credit history and healthy financials required

  • Greater access to more financing options from lenders

  • Minimum sales turnover required for trade-based financing

  • Guarantor/s’ credit bureau status affects success of application

Due to a lack of options, many companies typically self-finance their operations during the start-up phase. As a result, financing may be viewed negatively. Some common responses are:

  • “High financing cost”

  • “Reduces profit margins”

  • “Cash rich, do not require financing”

Lenders typically do not finance credit-poor companies thus applications that are done when the borrower faces factors such as cash crunch, declining sales, late receivables and bad debts are likely to be declined. SMEs may also be misadvised or use the wrong product(s) for their business capital needs; such scenarios would ultimately result in higher financing costs and reduce operating profits.

SMEs should analyse its future cash requirements to set an appropriate level of indebtedness. Cash needs should be linked to capital requirement and should be determined in the context of the company’s business environment. Effective cash flow and capital management should be done at least 6 to 9 months in advance to support projected revenue growth.

This also factors in the time required for financial preparation (in light of poor credit status), credit analysis and approval process from lenders. As a consequence, an adequate level of financial flexibility will be necessary to match the projected cash flows and corporate strategy of the business.

Business Capital Needs: Why a Business Needs Additional Capital

1. Cost Saving Opportunities:

a. Obtaining better equipment which will lower production costs and streamline operations, resulting in reduced operating expenses.

b. Taking advantage of quantity discounts or increasing stock prior to a supplier’s price increases to realise substantial savings on your inventory purchases.

2. Growth & Expansion:

a. Take advantage of developed opportunities.

b. Growth translates into a larger volume of receivables and bigger inventories.

c. Need to hold larger sums of cash to meet obligations with outside vendors & internal business needs.

d. Expand new branches, new products or increased capacities.

3. Inventory Control:

a. Seasonal events which demand building up of inventories and receivables may not be fully collected until well after the season ends.

b. Mismanagement of assets have allowed inventory and accounts receivables to be over or under stocked.

4. Economic Conditions Change:

a. Sales and profits have declined temporarily.

b. Due to changes in the economy, customers are slower and take a longer time to pay.

5. Cash Crunch:

a. Businesses are unable to meet current repayment of obligations and debts.

b. Failing to keep sufficient retained earnings in the business.

Capital Funding Pitfalls To Avoid

  • Not utilising specialised finance professionals to -

  • Formulate long-term and short-term finance strategies and objectives

  • Save considerable time and money in finding appropriate funding instruments and sources

  • Provide realistic transaction and terms perspectives and outlooks

  • The company’s long-term goals have changed, and its finance strategy has not been modified to reflect the changes.

  • Confusing short-term with long-term capital needs, thereby using inappropriate finance instruments and products.

  • Unaware of changes in financial product offerings and terms in the marketplace.

  • Lack of banking and funding relationship.

  • Lack of long-term and short-term planning.

  • Poorly conceived or executed capital structure and finance strategy.

  • Capital & finance instruments which are not customised to a company’s specific requirements.

Advantages & Benefits of Effective Financing

1) Enhancing supplier relations

Suppliers are happier when they get paid earlier and they are more prepared to continue to support your company should they know payment will arrive fast as this helps them to go about their business quicker as well. This is especially true for newly established or newer SMEs as effective financing can help to enhance relationships with suppliers.

2) Increase profit margins

SMEs can leverage on trade financing to pay their suppliers earlier and use this to negotiate for discounts with their suppliers. Usually rebates or discounts for paying off early can be as high as 3 to 5%, which more than covers the financing costs and thus increases gross margins. This means SMEs can enjoy greater sales and profits by leveraging on trade financing.

3) Higher quantum means more sales

Lenders are more likely to extend higher limits on trade facilities than other cash limits (e.g. overdraft). With the higher limits, SMEs can therefore do more sales and increase their turnover. For example, if the lender grants a trade line of $500,000 with 120 days tenor, clients can increase their turnover or purchasing power to an additional $1.5 million per year.

4) Free up substantial cash flow

By using financing to pay off suppliers, cash flow can be used to work on other opportunities or to pay for other expenses. Since the trade facility is self-liquidating, it is good sense to go through financing instead of missing out on sales potential due to cash flow limitations. As per the abovementioned example, if the lender grants a trade facility of $500,000 with 120 days tenor, SMEs can free up cash flow up to $1.5 million per year. Just imagine what your business can do with an additional $1.5 million a year!

With the right knowledge and clear understanding of the market, SMEs can address their financing needs more effectively and leverage on that knowledge to grow their business strategically.

- Janus Lim, Founder, Finaqe Group -