With a second lockdown upon us, Britain’s small businesses once again find themselves facing a testing period and planning what they need to do to endure it. And yet – whilst it may never have seemed further off – a time will come in the not-too-distant future when the SME mind-set can finally return to thriving, rather than merely surviving.
Management can then reflect on what will lead them to prosper under the more benevolent conditions we all hope await us. Some will contemplate hiring new staff, others will plan digital marketing campaigns, and many will reach the conclusion that sourcing funding is necessary to fuel these ambitions.
Chances are that with government loan programmes like the Bounce Back Loan Scheme likely retired, those who seek funding will look first to their debtor books – the money owed to them by their customers – to unlock this funding. Indeed, we live in what the British Business Bank described in its Small Business Finance Markets 2018/19 report as “the world’s largest invoice finance market”, with “invoice finance… still the most commonly used product” amongst SMEs.
Lenders have looked to trade debtors as a key source of security for generations – and for good reason. Aside from cash, the debtor book is almost always the most liquid asset on the balance sheet. In an event of default, it provides a lender with a relatively straightforward route to recouping its capital.
Whilst we at ArchOver are not a traditional invoice finance provider, we too look at the debtor books of prospective borrowers as a source of lending security and analyse potential recoverability rates. But they can tell us much more than this.
Debt does not improve with age, and if clients aren’t paying to terms we must ask “why?” The answers can be illuminating.
Could it be bad management? ArchOver looks at a wide range of metrics when analysing lending propositions, but the bottom line is that we must ‘buy’ a business’ management to lend. Under normal lending conditions, we take a dim view of management teams that let debtor collections slip; this often indicates to us that other parts of the business will be similarly poorly managed.
Is it that the goods or services being provided are poor or defective? This is an obvious red-flag to any lender, again prompting concerns about management and their control of the business as well as the collectability of the security.
Is it late payment? This is viewed differently. Late payment is a deep-seated problem that plagues SMEs through no direct fault of management. In fact, it has been described by the National Chairman of the Federation of Small Businesses as their “biggest challenge.” The root cause is often a power imbalance between SMEs and their larger clients and it is enough of an issue to have attracted government attention. Eye-catching research from Tide published earlier this year (before the pandemic) suggests that at that point UK SMEs were “chasing more than £50bn”. It goes without saying that COVID-19 will only have made the problem more acute. This overdue debt represents a drag on liquidity and pursuing it is a huge time cost, detracting from the time available to simply manage the business.
Late payment causes problems for lenders too, impacting borrowers’ cash flow and their ability to make scheduled payments. Recognising this, some management teams turn to third parties to help them address this issue. A willingness to engage with services such as Escalate Disputes shows that a management team is pro-active in identifying problems and recognises the cost and distraction of chasing debts in house. As a lender, that’s the kind of clear headedness we like to see.