How to keep the money flowing

IN business, working capital is everything. It’s quite literally the life’s blood of a firm large or small. Without it trading is difficult, growth impossible and survival unlikely. 

Until now, businesses in need of some extra cash would have had called upon their bank manager and in recent times past they would have been met with open arms. But traditional bank funding has suffered immeasurably as a result of the credit crisis and despite assurances from the country’s high street lenders that money is still being leant funds have seemingly dried up.

As a result, SMEs are looking to alternative forms of finance to raise capital. And it seems that the banking sector’s “troubles” has helped boost the popularity of otherwise low profile fund-raising methods such as asset based finance.
According to figures from the Asset Based Finance Association (ABFA) during the first half of the year the industry advanced more than £17.3bn against invoices, stock, property and other trading assets worth a total of £31.2bn – a growth of 15%.

Traditional funding to private non-financial organisations grew by 13.2% over the same period. Expectations are understandably high for the second half.
Kate Sharp, chief executive officer of the ABFA, believes that as the economy tightens securing traditional funding through banks and other financial organisations will become even more difficult.

“Companies are examining their own balance sheets more closely to identify where capital is tied up and how they can become more aggressive about utilising their assets,” she says.

“The format of securing outside investment is no longer possible so firms are looking within themselves to generate funding that will grow in line with their business.”

But according to Sarah Britain, solicitor in Keeble Hawson’s restructuring and insolvency team, SMEs need to re-address their business operations and restructure assets as well as explore alternative finance options.

“Where possible, finance periods should be extended to release additional money to bolder the predicted challenging months ahead or re-invested in guaranteed revenue generation,” she advises.

“Invoice discounting is a further relatively easy method for smaller firms to increase working capital. For instance where a company does not currently have an invoice finance facility in place, obtaining one would not only provide a working capital lump sum on day one of the facility, but would also accelerate the cash generated by invoices into the business.”

But there are other considerations that need to be taken into account. Offering cost effective prices will vastly increase the chances of not only being paid in full but on time, therefore generating further business.

However, Britain warns that such measures alone will not necessarily secure a firm’s success.

“SMEs need to examine every aspect of the business and restructure operations to make positive and finance generating changes such as credit control, prioritizing work undertaken and asset management.

“Every cost and resource should be analysed in detail to ensure maximum return on investment and if not, they need to be streamlined or eradicated completely. Therefore, it’s important to employ an objective point of view and seek professional advice.”

Jamie Williams, senior manager, entrepreneurial services in the Leeds office of business advisory firm Deloitte, agrees.

“The credit crunch has had a large impact on the availability of finance from financial institutions and the onset of recession continues to make life difficult,” he says.

“However, there is still finance available for those companies that have good management and a fundamentally sound business plan. A strong business plan, which includes robust and brutally realistic financial forecasts is paramount to gaining and/or renewing financing facilities.”

Even so, Williams admits that the cost of finance has increased significantly as financial institutions work on strengthening their balance sheets and improving profitability.

“We have seen banks move towards using LIBOR as an interest basis rather than the Base Rate, also non-utilisation and regulatory fees are also being introduced in new facilities with arrangement fees increasing significantly,” he informs.

RBS’s commitment not to increase borrowing costs is being hailed as a strong signal to the rest of the banking sector by Chancellor Alistair Darling, but concerns that monies provided for funding through recapitalisation are not being passed on are growing – fast.

As Williams explains, short term debt in the form of overdrafts are the norm to finance day to day working capital requirements. The downside he points out is that they are usually repayable on demand and in the current climate attract a high interest rate.

Although long term debt historically has been secured against the assets of the company there has often also been a cashflow element to the debt, which was unsecured but based on the company’s current and future earnings.

The availability of unsecured cashflow finance has reduced significantly as a direct result of the credit crunch and financial institutions are moving more towards secure asset based lending. This can be short term (invoice discounting) or long term (operating lease, hire purchase) and generally attracts competitive interest rates and may also include other benefits (such as credit insurance for invoice discounting).

“As a result invoice discounting is now taking even higher prominence as this improves bank security and also reacts to business performance,” says Williams.

“The Small Firms Loan Guarantee Scheme is overlooked by some companies and is government backed and this may well be the vehicle that Alastair Darling uses to increase lending to SME’s.

“Grant funding is also sometimes overlooked, but should be investigated as there are currently a number of Yorkshire public/private funds which can fund amounts from £100,000 to £2.5m through loans and equity linked investments. This is often a cheaper source of finance than through banks.”

Bank lending isn’t the only option however. Equity finance can come from existing shareholders or family and friends. The initial cost may appear inexpensive (that is no interest cost), but William’s warns it may be a risky investment. Ultimately, however it will be costly to repay on an exit or sale of the business.

Other sources of finance, which generally require a higher rate of return include business angels and venture/development capital. This usually takes the form of an equity stake in the business with the investment being realised in a sale and/or exit from the business. Anecdotal evidence from the Yorkshire Association of Business Angels (YABA) confirms a rise in the number of firms considering this option.

The Chancellor’s pre-Budget report does offer some hope however. Around £7bn will be made available to small firms needing loans from £100,000 to £1m – and at “competitive” rates.

Just how quickly the banks resume “business as normal” status is anyone’s guess. Although actively protesting that they are still lending it is in the main only to existing clients. Working out the best option for raising working capital will need some agile thinking, sound advice, and a little luck.