Categories
Cash Management Funding Supply Chain

Supply Chain Finance for SME’s: Lessons from Greensill

Supply Chain Finance (SCF) is a useful way to fund SME’s. In this article we’ll explain what it is and why it’s useful. We’ll also analyse the recent collapse of one of the world’s most popular SCF providers, Greensill and finally take a stab at predicting what SCF will look like in the future.

Greensill Capital Supply Chain Finance

What is Supply Chain Finance and why is it useful?

SCF is a form of financing typically used by Small to Medium Enterprises (SME’s) when supplying products to larger companies. It’s often called Reverse Factoring because the SCF company uses the supplier’s sales invoices as security for the loan.

How is this different from regular Debtor Finance?

The major difference is that the customer is borrowing the money, not the supplier. That sounds great for an SME – no credit check for the supplier and because the customer is generally a large corporate the interest rate is lower.

Wait, what interest? You said the customer is borrowing the money?

That’s right – the customer is borrowing the money to pay the supplier but they pass the interest cost on to the supplier. In practice this means the supplier can choose to be paid sooner than the agreed payment term but the amount will be reduced by interest. Because the customer is larger they can generally access funding at a lower rate than the supplier can. This means it can be cheaper to use SCF than Debtor Finance!

Should my SME use SCF if it is offered?

Overall SCF is a relatively cheap and easy way to fund invoices with a few potential drawbacks. If you are able to access it via a large customer make sure you are comfortable with the rates and check it won’t conflict with your existing Debtor Finance facility.

You should also be aware that you’ll be relying on the funding agreement between your customer and the SCF lender. If that fails you may have a cashflow problem!

ProCon
No Credit CheckLimited to specific customer/s
Cheaper interest ratesSCF lender risk

What happened to Greensill?

Greensill Capital was founded in 2011 by Lex Greensill, a Bundaberg boy from a farming family who became a banker (Morgan Stanley, Citigroup). His family’s experience of cashflow problems selling sugar cane and melons inspired him to enter the world of invoice financing. Greensill Capital grew its SCF business quickly by converting its lending into notes and issuing bonds which allowed it to access more funding than if they had relied on a single bank (the traditional SCF model). Australian customers included UGL, Telstra, Vodafone, and Airbus.

Expanding beyond traditional SCF lending

Greensill expanded worldwide, and extended its SCF offering to consumers by purchasing Australian startup Earnd. A lucrative contract with UK’s National Health Service allowed Doctors, Nurses and other staff to drawdown their salary early (paying interest for the privilege). It also began lending to riskier businesses, taking out insurance to cover the risk of default.

Risky lending

One of those riskier businesses was Sanjeev Gupta’s group of companies. Gupta Family Group (GFG) companies accessed Greensill SCF funding for invoices including between their own companies. These are now suspected to be sham invoices. By the time Greensill collapsed their exposure to GFG was around $5 billion.

Criminal investigations

The suspect GFG invoices were eventually noticed by the German financial regulator BaFin. BaFin conducted a criminal investigation into Greensill Bank and concluded that Greensill had lent money to GFG for invoices that weren’t real.

Bye bye Insurance

Greensill’s loans were insured through a subsidiary of Insurance Australia Group (IAG) which was later acquired by Tokio Marine.

In 2020 Tokio Marine advised Greensill that some of the insurance policies were potentially invalid. They also said they would not renew the policies in the next year.

The end of Greensill Capital

Greensill Capital filed for Administration in March 2021. They had

What’s the future for SCF?

The Greensill saga highlights the risk for an SME in relying on an SCF arrangement. If you have one of these arrangements in place your cashflow is at risk if the facility suddenly ceases. Because it’s probably related to your largest customer this could be a big problem so it’s a good idea to find an alternative source of funding if needed. But apart from a Greensill-style collapse, what other issues could harm your customer’s SCF facility?

Regulatory changes

In the wake of Greensill regulators will increase scrutiny of these arrangements, and investors and insurers will be acutely aware of the risks inherent in this type of lending. This will probably lead to rate increases and even cancellation for some smaller, riskier customers.

Accounting changes

SCF is generally not visible in the financial statements. They simply show those liabilities as Trade Creditors instead. Mostly they don’t show enough detail to see if amounts are owing to suppliers or to SCF financiers.

The accounting profession is moving towards presenting SCF liabilities separately on the Balance Sheet so its clear they represent short-term loans rather than Creditor liabilities. Along with this will come better disclousre of the nature of the debt.

This is boring accounting stuff, why is it relevant?

It’s relevant because this will affect the types of financial measures that affect how businesses can attract lending and investment. The result could be that some businesses decide its better for them to close down SCF facilities!

What to do if my SME is offered SCF?

The lure of being able to access customer payments immediately is very strong, and can be very helpful to your business. Whether you’re considering a new SCF arrangement or evaluating the potential impact of your current SCF failing, make sure you:

  • Model the cashflow impact with and without SCF;
  • Forecast the P&L impact of the additional interest expense;
  • Check if the SCF conflicts with existing or planned Debtor Finance facility.
Categories
Business Strategy Cash Management Funding Lending Supply Chain

The CFO’s Guide to SME Funding

Funding

The CFO’s Guide to SME Funding: Maybe you’ve started your business and are gearing up to supply some big new customer contracts. Maybe you’ve recently bought a business. One of the best challenges to have in business is determining the best way to fund growth. Most SME businesses don’t have enough earnings or external investment to fund their growth, so rely on financing. Businesses have been borrowing to fund growth for centuries so there are plenty of options. In this article we’ll explain the most common options for funding your growth.

How do I arrange funding for my SME?

If you’re going to borrow money from a bank you’ll need to show at least two things: – security and ability to repay.

Security

As nice as your bank’s relationship manager is, they won’t be able to help you unless you have some sort of asset to use as security for the lending. This can be an actual physical asset or a financial one. We’ll discuss the types of assets commonly used as security later in this article where we dive into different types of funding.

Ability to repay

This seems like common sense, right? You’re asking for money to spend on growing your business so of course you’ll be able to repay it. The thing is, you need to show the bank how and when you will be able to repay the loan. Financial forecasts are the best way to show this. Make them realistic though – the credit department making the final decision on your loan sees a lot of these every year so they’re very good at smelling BS.

Equipment Finance

Most businesses will need some type of assets to help them grow. Sometimes called “revenue-generating” assets, these give the lender both security (because they’re physical assets that can be sold to repay the loan if you default) as well as ability to repay (if your business plan and financial forecasts clearly explain how it will support business growth).

Equipment Finance lending applications can generally be processed quickly by lenders.

Debtor Finance

Lending using your customer invoices is a flexible way to fund business growth. The lender’s security is the right to receive customer payments for those invoices (a variation on this is factoring, where the invoices are actually sold to the lender who takes responsibility for chasing payment). Things to be aware/ careful of:

  • These facilities are either confidential (your customers don’t know) or disclosed (your customers must be told).
  • Debtor insurance may be necessary to enable funding for customers with a higher risk profile.
  • Bad paying customers will reduce lending capacity in the long run.

Trade Finance

A lending facility designed to extend your payments for goods is a great tool to fund growth for retail, wholesale and import/export businesses. It allows you to better match your sales income with supplier payments which is good news for cashflow if your business is growing rapidly. Points to note include:

  • These facilities may also be called Letters of Credit (LC’s), Import Finance, and more.
  • The goods being purchased are the security in this type of lending, so the lender will need proof that they actually exist before any money is paid. Make yourself aware of their requirements!
  • Gathering the necessary paperwork to get payments approved by the lender can take time. Give yourself enough time for this – especially if your supplier is overseas. You’ll often need to pay a deposit very close to the goods being loaded onto a container ship so don’t leave it too late to arrange funding.

Supply Chain Finance

AKA Reverse Factoring, SCF funds invoices on the buyer’s side rather than the seller’s. Once the buyer approves an invoice the seller can immediately request payment of the invoice. This helps both parties:

  • The buyer can access longer payment terms through SCF.
  • When the buyer has a better credit rating the seller can access a better interest rate than if they had used traditional Debtor Finance.

As a seller you are not applying for lending by entering into your customer’s SCF arrangement – great! Just check first that it doesn’t conflict with your own Debtor Finance facility.

Overdraft

At first an overdraft can seem like the simplest type of SME funding. It’s just paying interest on an overdrawn bank account, right? Actually while it’s very flexible, it’s the most difficult one to access as it has no inherent security associated with it. Because of this lenders will generally seek alternative security, such as property (either from the business or the owner personally). This can mean taking on a much larger risk than the value of the overdraft!

My funding is in place, what’s next?

Well done, securing the right funding to help your business grow is the first important step!

Next you need to stay on top of your cashflow. Minimising your business’s cash conversion cycle (time to convert your inventory into cash) means you have more funding capacity for growth. You do this by managing your debtors, inventory and creditors closely, and monitoring your cash regularly. To paraphrase a wise CFO:

The best time to forecast your cash for the next 3-4 months on a weekly basis was last month. The second best time is now!

Categories
Cash Management

Be the King of Cash

Whether your business is large or small, commercial or not for profit, selling goods or services, cash is the lifeblood that needs to flow through it. This requires focus – since Cash is King, you need to be the King of Cash.

“Making more money will not solve your problems if cash flow management is your problem”

Cash Management is all about making sure the lifeblood flows through your business. You need to focus on making sure it:

  1. Is regularly monitored
  2. Flows in consistently and predictably
  3. Is used effectively and efficiently within the business
  4. Flows out regularly in line with deadlines

1. Monitor cashflow regularly

Plan your cashflow. Just as you set targets for sales and expenses, you need to convert these to cash inflows and outflows. These days there are many tools to help you do this. I recommend cloud forecasting solutions such as Calxa (an Australian product) or Futrli. They can be integrated with your cloud accounting software (eg Xero, Quickbooks etc) within minutes. Their online training will help you convert your revenue and expense forecasts, or a good accountant/adviser will be able to assist or do this for you.

Check your performance regularly. Things always change so make sure you know how those changes will impact your cash forecast. Understand what is driving those changes, for example:

  • If sales are down, is is temporary? Are they delayed or gone forever?
  • Are some of your customers suddenly paying later?
  • Do you have unexpected expenses?

Proactive financing. Arrange financing to cover times of temporary cash shortage or low cash balances. For example:

  • Invoice Financing;
  • Working Capital Financing;
  • Equipment Financing;
  • Long-term Loan;
  • Overdraft or others.

Take action. Even with financing in place you’ll need to keep on top of your cash movements. The next sections detail actions you can take.

2. Ensure cash inflows are predictable and consistent

This is all about getting your customers to pay when you need them to. Some tasks may be difficult however are necessary to make sure enough cash comes in to support your business.

Set short payment terms and review regularly. Don’t just default to 30 day terms – default to CBD, 7 or 14 days wherever possible. If you notice customers are consistently paying late then discuss this with them asap. You can also nudge them towards paying earlier using techniques such as:

  • Late payment penalties;
  • Early payment discounts;
  • Temporary reduction in payment terms (eg Cash in Advance for 2 months);
  • Direct Debit technology such as Go Cardless and Pinch Payments (both Australian products) are extremely easy to integrate with cloud accounting systems. Your customers save time in paying you and you get certainty of payment.
  • Consider debtor insurance as consistently paying late can be a sign that your customer is in trouble. In the worst case they go into administration or liquidation, and you have a large hole in your cashflow. If your total AR balance is concentrated in only a few customers, there is a large risk to your business continuity if one of them can’t pay you.

Chase your debts regularly. Consistent, regular contact with customers increases the likelihood they will pay on time. Technology is also your friend here, with a number of apps that integrate with cloud accounting system to automate reminder sending, such as Chaser, EzyCollect (Australian product), and Debtor Daddy. Features can include automation for:

  • Email reminders;
  • SMS reminders;
  • Voice reminders;
  • Escalations within your business;
  • Escalations within your customer’s business;
  • AR specialists to call your customer;
  • Debt collection or legal processes.

Think about what type of reminders will work best for your customers and see the results.

3. Use your cash efficiently and effectively within your business

The hard work in choosing which business activities to spend cash on to deliver and manage your goods/services should happen when you prepare your forecast or budget. Don’t take the easy way out and just copy last year’s costs to this year. Assess them in line with your revenue expectations.

Take time to understand how your expenses drive / support your revenue. All parts of your business contribute to your top line and/or your bottom line. You can adjust the way your business works by changing your spend but remember that they work together. For example if you increase marketing spend to increase revenue there will be a point at which you need to increase spend in other areas to keep up. Likewise you need to understand the impact of reducing expenses in specific areas on the rest of the business.

Measure what counts! Once you understand how your expenses drive / support your revenue, measure performance in those areas so you know they are effective. What you measure drives performance, so make sure to focus on only 1 or 2 things. Measure outcomes instead of workload. Your measures will be specific to your business, but some examples include:

  • Number of new customers
  • Lead conversion rate
  • On Time In Full (OTIF) delivery %
  • Customer Satisfaction score
  • Staff Satisfaction score
  • Days Sales Outstanding (DSO)

4. Ensure payments are made regularly

Good regular payment behaviour sometimes gets forgotten (especially when times are tough). It is however an essential part of good cash management.

Spread payments out to minimise large cash outflows. Smaller payments more frequently are easier to manage in line with your cash inflows, especially if your inflows are regular and predictable.

Don’t delay paying your suppliers without talking to them first. You rely on your suppliers – you have a relationship with them. Paying them later than agreed may not have an immediate impact, but we all remember our customers that consistently paid late. Some businesses rely on government guidelines for small claims or statutory demand thresholds to delay or even avoid paying suppliers. This will always catch up with them as their suppliers will eventually stop supplying them altogether.

Never delay paying statutory obligations without making a payment arrangement. Sometimes your business might have a temporary cash issue and can’t make statutory payments such as PAYG, Income Tax, Superannuation, Payroll Tax etc. If this is the case, contact the relevant authority and request a payment plan or extension. Penalties can apply for late payments and directors are personally liable for non-payment of some obligations.

Be the King of Cash

Now that you understand these four principles of cash management, become the King of Cash by implementing them in your business. A good accountant/adviser can work with you to make this happen.