Fit for Purpose Finance

In 2015 business owners are spoilt for choice when it comes to finance options to help bolster cashflow and instil growth. Debtor financing and invoice financing especially have now become mainstream solutions.

Business finance has made giant strides since the days when owners went cap in hand to the bank manager for a loan. I recall my father putting on a tie and jacket in the late 60s to nervously meet with the manager of the local Bank of New Zealand to extend the overdraft on his dairy-grocery business. Who would have thought that some 45 years later, there would be such a plethora of finance options available to business owners looking to grow their business or smooth the cashflow.

We’ve since discovered the power of balance sheet assets – money owed from the sale of goods or services that can be accessed virtually straight away, thanks to the services of a growing number of finance providers.

We are, of course, talking about the various forms of factoring – and debtor or invoice financing – finance options that have slowly but surely been gaining widespread acceptance in New Zealand’s business community over the past decade or two. I say ‘slowly’ because this form of finance was universally accepted overseas long before people got the hang of it here.

And yet there is still some confusion surrounding the different options – so an explanation is called for.

Perhaps the best explanation is one from the Debtor and Invoice Finance Association of Australia and New Zealand, which reads:
“Factoring and discounting, also known as cashflow or debtor finance, are among the most powerful financial tools available to business. Invoice Discounting simply involves a business turning its unpaid invoices into cash. The business literally sells its unpaid invoices to the discounter. Factoring involves the sale of a business’s unpaid invoices as with discounting, but in addition the sales accounting functions may be provided by the factor, who manages the sales ledger and collection of accounts.”

Andrew Dunning, a director at Fifo Capital also believes there is still a general gap in understanding about the breadth of finance solutions available outside of what the banks offer. “Short term advances, stock finance, payment terms for clients, and one-off invoice finance, when backed by expert consultancy, can be powerful tools for a growing business,” he says.

But the key, he says, is expert consultancy. “The finance has to be fit for purpose, so that means working with someone who will assess what the need is and then find a solution, not a product, to help the business achieve the end goal.”

So the message here is to match finance solutions with specific business requirements. It’s not surprising then that most finance providers have multiple solutions in their arsenal.

Of course, the big deal about these alternatives to bank finance, and one that Craig Brown, general manager lending, at Lock Finance thinks should be shouted from the rooftops, is that no property is required as security for these working capital facilities. It is secured through the business’s own asset base – the debtors ledger, or individual invoices – depending on which option you go for.

That means the family home is safe.

“Why continue to fund plant and machinery, vehicles and cashflow from bricks and mortar?” asks Brown. “Use a lender that is a specialist in that asset. Will the banks lend up to 80 to 90 percent of the value of a receivables ledger? Unlikely!”

Brown wonders what will happen in the future when younger business owners look to obtain business finance when they can’t even afford to buy a house to use for security.
“I know a 27 year old who started his own business, which is now only 12 months old but turning over $400k and looking to double this year. A bank may only provide a small ‘unsecured’ $20k overdraft. He has no property to leverage against, so how does he grow his business? The answer is a cashflow facility where he can leverage against his business debtors.”

Brown believes that reduced home ownership will mean that more and more business owners, especially at the SME level, will need to look at other funding options.

What about the cost?
Unfortunately there can still be confusion surrounding the true cost of these alternative funding options, and understandably cost still appears to be the main driver when looking for a cashflow facility. “Cashflow facilities secured by property, from the likes of banks, do attract a cheaper rate,” explains Brown. “However, when dealing with a reputable provider you’ll see that the costs may not be as much as you’re initially led to believe. There is still a lot of misinformation about this.

“Would you pay more to access a higher level of cash? If a bank is limiting your overdraft limit then what is the opportunity cost? If you look to sell a shareholding to just bring in more cash to assist with cashflow, what is the cost of losing a share in your business?

“Why offer a ten percent discount to clients to get debtors to pay quicker when the cost of a cashflow facility may only be two to three percent?” he asks. “So you tell me, what is expensive?”

On the subject of banks, ironically the BNZ, whose predecessor my dear old Dad went cap in hand to, has been a leader in invoice financing in this country in recent times.
And there’s confusion surrounding invoice finance as well.

“Unfortunately confusion does exist as invoice finance can be used either as a short term financing [option] for an event that has happened or for longer periods,” explains Andrew McKerrow, senior product manager-cashflow solutions for BNZ Product and Customer Solutions. “Short term [invoice finance] could be used to fund a new supply contract for say three to 12 months. For longer sustained growth periods it’s ideal, with the cashflow funding matching the needs of the business and the growing business assets (debtors), which is used for security.”

McKerrow says invoice finance is recognised worldwide in financial markets as one of the best cashflow solutions for a growing business, given its flexibility to match the ebb and flow of sales; whereas an overdraft means a business is reliant on its level of tangible security and/or someone paying them to pay their own bills.

“It is sometimes seen in New Zealand as a lender of last resort whereas it should be seen as a first choice of lending – given the cashflow it generates at point of sale is what a business needs to survive.

“With BNZ invoice finance a client can potentially make money by using the extra cash to get supplier discounts for prompt payment,” adds McKerrow, “so benefits vary dependant on the flexibility of the funding facility and the use of the money to derive a ‘value versus cost’ equation. Fifo Capital’s Dunning says the key benefits of as-needed invoice discounting are speed and flexibility. “We turn around finance needed in as little as four hours for existing clients and between 24 and 48 hours for new clients,” he says. “And clients can use us as and when needed without impacting other finance facilities.”

Cost has to be considered in relation to the purpose of the finance, he believes. “The cost is too high if the finance is not going to solve the issue or enable the business to achieve a goal. On the other hand, as in a recent client experience, not obtaining finance would have meant walking away from a $36,000 opportunity. In this case, the client had an unexpected opportunity to purchase stock and on-sell for a healthy return. As they did not have the capital, we funded the full value of the purchase up front.”
Cost is also all about the timing, he says. “Understanding alternative finance options, and assessing how they can support the business model in line with traditional finance facilities, margins and opportunities, can be a powerful tool for business.”

Deciding on the best option
The most important thing to understand when sizing up alternative funding options is the finance purpose and what the business wants to achieve.

“You can’t just take a financial product and squeeze the business need to fit it,” says Fifo Capital’s Dunning. “It’s about understanding the purpose and goals, working through how the client is going to achieve what they want, and assessing the best solution that works with their business model.”

Simon Thomson of Cashflow Funding says the following questions are generally raised when ascertaining a business’s needs.

• Are you seeking a long term or short term solution?
• Tell me about the size and nature of your debtors ledger?
• What trading terms do you give your customers, and what security is available?
• What existing facilities do you have? (bank overdraft, limit, cost, etc.)

He will also want to know whether you are getting a good deal from your existing bank or financier. “And are you funding your short term needs (working capital) with current assets or fixed assets? It should be current assets – why put your fixed assets up for security!?”

Another key point is for business owners to know their options ahead of time, says Andrew Dunning. “When we have the opportunity to work alongside accountants and in a planning capacity for clients, a number of smart financial options and processes can be achieved. Looking at client arrangements, we can assess options that work with their margins and support the growth and financial health of the business.”

Fifo’s options are a good indicator of the diversity of solutions available in today’s market. In a nutshell they are:
Invoice finance: One-off early payment on receivables for short term cashflow needs. Clients can submit one invoice (or a portion of its value) or multiples to secure short term finance when needed.

Stock finance: Upfront capital to purchase stock which is then on-sold; the ability to cover the upfront cost of purchasing stock to generate sales on which payment can be 30 days or more in the future. This is particularly powerful for importers.

Business loans: Short term loans for three to 12 months with the ability to secure against multiple business assets.
Payment plans: Payment terms for customers of clients, enabling the client to receive up to 100 percent of the receivable upfront, which their client pays back over time. Particularly powerful for clients providing large asset purchases or one-off project outcomes that represent a significant investment for their client.

With finance solutions as diverse as these on the market, business owners wanting to expand their enterprises have simply never had it so good. But always remember that the best finance solution will come from working with an expert who takes the time to understand your business.

Something I’m sure that rarely happened back in the day when business owners like my Dad went down on bended knee before the almighty bank manager.