Growing Pains Part One - Engaging Your People

SME businesses face a greater challenge when looking to raise capital than listed companies. Equity capital is difficult to source and often involves an arduous process. As Private Equity Firms are often a costly option debt financing is more commonly used. The challenge facing most SME businesses, apart from qualifying for the debt finance itself, is selecting the optimal mix to match the underlying needs.

SME businesses are often tempted to use one source of debt finance for all needs. For example, a line of credit such as an overdraft.

Notwithstanding its simplicity, it may not be the most cost effective approach or the most efficient choice. For example a common use of overdrafts is to fund cashflow shortfalls due to working capital lock up.

The problem with this approach is that it may be masking operational deficiencies such as inadequate debtors or inventory management, suboptimal supply chain arrangements or unprofitable pricing models.

Transaction based debt funding such as invoice financing and trade finance may appear burdensome from a compliance perspective, however when used appropriately can facilitate the implementation of improved working capital and supply chain management practices. For example if you import in USD and either require some lead time to manufacture or need to stockpile inventory, then why not use a USD trade finance facility to fund your purchases?

These purchases can often be funded for up to 180 days and with US interest rates at record lows will allow you to increase your buying power cost effectively, enabling you to negotiate lower cost of goods. Combining this facility with improving inbound/outbound logistics, whether they are in house or outsourced, can further lower your cost of goods sold leading to maintained or even increased margins.

If you are not in the enviable position of collecting payment upon delivery of your service or goods, then your business is most likely required to provide credit terms to customers. In this instance invoice financing is often used when an overdraft facility is not available or if there is no reason to have trade finance (i.e. you do not hold inventory). Combined with a trade finance facility the two funding sources will enable you to unlock your working capital. Ideally though, invoice financing should only be a temporary measure until the growth of the business stabilises. The sustainable strategy to manage trade debtors should be to improve your collection process.

Funding growth with debt should be temporary. Continual use in the absence of rapid growth may be symptomatic of underlying problems within the business, such as an unprofitable business model or ineffective management practices. There is no substitute for a robust business plan augmented by rigorous performance management processes and governance.