By Rowan Lemley, Senior Manager at Basware
Payment friction, (which is created by conflicting interests i.e. buyers wanting to pay as late as possible and suppliers wanting to be paid as early as possible) is as old as trade itself. In fact, there are recorded descriptions of factoring solutions being offered as far back as the Roman Empire. So, you’d think given how long it’s been going on – it should be pretty straightforward to master, right? Wrong. While it sounds simple, the situation in fact is complicated by invoicing being both a debt title and a tax medium for VAT. Therefore there are a large number of legal constraints on what, where and how receivables financing can be done.
Suppliers have turned to specific credit lines, or even overdrafts, to help finance their working capital needs. Not only is this quite risky because of the non-committed aspect of these lines, but also costly as they rely solely on the credit rating assessment of the supplier company rather than the true risk of customer payment default risk. Some suppliers even resort to using credit cards to finance their business which are known to carry some of the highest financing costs in the market. They also traditionally favour the buyer in terms of reversal. This is not conducive to a friendly business environment for our largest employment contributors (small and medium businesses).
For many years, governments have pursued and implemented several initiatives to support and enhance SME financing.
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Some governmental initiatives are trying to reduce, or at least control, the payment terms between buyer and supplier – such as the EU’s Late Payments Directive (which is really payment term legislation) or the UK’s Small Business, Enterprise and Employment Act (which is only applicable to government entities).
The financial industry is also investing and developing new technology savvy solutions (Fintech) that are able to reduce risk and offer lower rate financing to small companies. Some financing models that leverage the large buyers’ credit rating to allow suppliers to access low interest rates alternative financing have been quite popular. These solutions are built on a complex set of technology capabilities and legal frameworks. They are financially attractive, albeit constraining in terms of eligible invoices.
Despite all these efforts though, the actual market situation is not improving. In the UK alone, the funding gap for SMEs is estimated at £59bn; with 25% of UK SMEs currently ‘exceeding their working capital’ and some 18% at risk of overtrading (in other words; at risk of Working Capital related bankruptcy).
In fact, the situation is actually worsening. Traditional lenders like Banks face increasing regulations to de-risk their portfolio (think Basel III) and are reducing or even removing overdraft facilities to SMEs (30% of SME’s have been impacted in the last 2 years, with 17% of SMEs seeing their overdraft facility completely withdrawn). This is putting extreme strain on SME working capital access and significantly raising the risk of bankruptcy and disruption on the supply side of large companies.
Supplier centric solutions such as that offered by Virtaus (and other Fintech companies) provide an interesting alternative financing opportunity for UK Suppliers. These technology houses are connected to an origination network (a platform that contains invoices) and to financiers. They automatically run risk analysis based on a complex algorithm and multi-dimensional data to provide accurate risk assessment and deliver financing options to suppliers. Unlike their traditional factoring competitors, these new Fintech providers do not approach risk from a Debtor portfolio perspective, they look at the risk of the transaction itself and are therefore able to offer financing at an individual invoice level.
Ultimately the question may not be ‘how can the government do more to help SMEs?’ but rather, ‘how will the industry innovate and reinvent itself to provide the necessary agility and low cost funding to the small and mid-sized businesses?’