Business Planning: Varying the financing mix

Last year was a time of great change for small and medium enterprises (SMEs), with tightening credit markets and an easing in demand for goods and services, a trend set to continue in 2009.

In these circumstances, as the credit squeeze intensifies thereby crimping access to finance and debtors’ days lengthen, many business owners, if they haven’t already done so, turn to their personal assets to free up much needed capital to fund their cash flow or capitalise their businesses.

Business owners should ensure they have explored all the options before mortgaging their personal assets or injecting personal funds into the business. There are other options available to them, one of which is using the business’ debtors to access much needed cash flow.

In many cases it is possible for the business to raise its own funds secured against its own accounts receivable and, in so doing, provide a dynamic source of cash flow.

By using debtors to secure business finance, owners can refinance their business finance, which previously required their personal homes or other assets as security, or repay loans they had advanced personally to support the business.

In both of these cases it creates a separation between business and personal financial objectives.

If the business owner decides to take the receivables financing route, finance is typically made available up to 80 to 90 per cent of outstanding accounts receivable, freeing up money to pay salaries, buy or upgrade equipment or fund expansion. This is particularly relevant if the business owner’s home is already mortgaged for the business or they don’t wish to mortgage their home, or where they lack business assets to secure a traditional loan.

As sales grow, so does the value of accounts receivable and the level of funding available to the business — all of which provide a compelling structure for a growing business. The fact that the funding is secured against the accounts receivable of the business rather than bricks and mortar or personal assets is a key benefit for owners or directors of the business.

It allows the business to be self-funding rather than shackled to the external assets of the principals. It is also an option that is particularly relevant for businesses with stronger balance sheets and those looking to effect acquisitions over the coming year.

Business owners who use their accounts receivable to access cash flow are using it across three key areas.

The first is funding early payment supplier programs whereby they negotiate an early settlement discount of 3 to 6 per cent for a seven-day payment.

A business with, for example, $1 million in annual purchases could deliver up to $40,000 to the bottom line after financing costs, all without making any additional sales.

The second is funding lengthening debtors’ days. Late payments are on the increase and are turning up the heat on many small Australian businesses. Credit terms are stretching out from 55 to over 60 days and, in some instances, to between 90 and 120 days.

This creates major headaches for small to medium businesses when it comes to managing their cash flows and paying suppliers.

It can be particularly severe for businesses supplying the mining and construction industries, where payment terms can be particularly slow, or for businesses with large companies as their customers.

In addition, listed companies are increasingly using their size to demand extended credit terms, saving interest costs by shifting their borrowing to their suppliers. These factors are making life harder for small and medium businesses.

Businesses using receivables finance in these instances are releasing immediate cash to pay salaries and suppliers, make purchases and repairs, and some are expanding the business.

The third is where businesses are using it to fund ‘big ticket’ business events such as management buyouts, partner buyouts and acquisition of competitors or complementary businesses, refinancing parent company loans as well as funding new product and business lines.

It’s not unusual today to see funding for an acquisition comprising a mix of receivables finance, some equity contributed by the directors or the acquiring parent entity and some straight debt based on traditional bricks and mortar secured funding.

But most businesses are still unaware of the power of their accounts receivable to leverage these opportunities. In fact, I have seen many cases where a business has turned down opportunities such as buying a competitor because they were not aware they could use their accounts receivable in the funding mix.

By leveraging their accounts receivable to assist in funding these major growth opportunities, management can dramatically change the future scale and profit potential of the business.

The benefits are immediately apparent in the case of an acquisition.

The acquiring entity can not only leverage its own accounts receivable but the new receivables created by the target company following the acquisition to meet the increased cash requirements of the expanded group.

Receivables financiers now contribute more than $66 billion in funding to SMEs in Australia and New Zealand per annum.

Brendan Green is the national manager, cashflow finance, at St George Bank and chairman of the Institute for Factors and Discounters.