Solving the SME credit squeeze

Greg Charlwood, MD of Australian Invoice Finance, presents an alternative solution

SMEs are battling a credit crunch, and they are pointing the finger at the royal commission into financial services for causing the big four banks to further pull back on lending.

In a report released in September 2018, the RBA said the proportion of small businesses that perceived it to be relatively easy to access finance was already in decline.

The RBA also noted that many small businesses found it challenging to access finance, particularly without providing real estate as security.

On the other side of the coin, traditional lenders say they are keen to lend to small businesses, but unsecured finance exposes them to a higher degree of risk.

APRA has been gradually tightening loan serviceability rules over recent years, forcing banks to apply tougher tests of borrowers’ income and expenses.

Under the Basel III rules that were introduced in the wake of the 2008 GFC, banks were required to hold more capital against small business loans, which made the provision of that credit more expensive and therefore costlier for the borrower.

More recently, banks also began to apply stricter checks on loan applications, delaying the time it took for loans to be approved.

Combined, the extra cost and time associated with bank credit means that the banking sector is now unable to adequately meet the credit demands of more than two million Australian small businesses.

Small business borrowing against invoices

Working capital is the lifeblood of small business, but in Australia late payment of invoices is the number one problem. It reduces cash flow, restricts opportunity for growth and even threatens to put some small businesses out of operation.

It is so bad that the Australian Small Business and Family Enterprise Ombudsman, Kate Carnell, initiated a review of payment times.

She did so after an inquiry found that Australian late payment times were among the worst in the world, with invoices paid on average 26.4 days late.

An inquiry found that Australian late payment times were among the worst in the world, with invoices paid on average 26.4 days late

The inquiry also identified a growing trend for large Australian and multinational companies to delay and extend payments from 30 days to 45, 60, 90 or even 120 days.

Carnell recently issued a report with 10 key recommendations, including that the Australian government should legislate to set minimum repayment times for larger businesses.

The Liberal/National Coalition responded by announcing it would require all government entities to make payments within 20 calendar days.

While this will help suppliers to government departments, there is an alternative solution for the companies that sell their goods and services primarily to the private sector.

Invoice factoring and invoice financing are both alternative finance sources that can release the funds tied up in a business’s unpaid invoices, involving a lender who agrees to advance money against outstanding debtor balances.

The essential difference between invoice factoring and invoice financing lies in who collects the accounts receivables.

With factoring, the lender runs the accounts receivables and takes over chasing payment from the buyers.

Under an invoice discounting arrangement, the seller is responsible for chasing payment of outstanding invoices.

Most invoice lenders will lend up to 80% of unpaid invoices, whereas Australian Invoice Finance will lend up to 85% of unpaid business invoices and offer fast, same-day approval.

Government and political support for small business

The government has belatedly proposed other changes that, if introduced, could also help provide small businesses with better access to credit.

The government’s 2017 review into open banking aimed to promote greater competition within the banking system.

Key recommendations included facilitation of an economy-wide, consumer-directed data transfer system, and further that the rules around open banking should include standards for transfer of data and security.

Mandatory comprehensive credit reporting (CCR) will come into full effect on 1 July 2019 and will be vital to the development of the small business credit market, enabling lenders to access both positive and negative credit reports.

In October 2018 Prime Minister Scott Morrison called for reform to boost small business, and proposed initiatives such as the $2bn Australian business securitisation fund to provide additional funding to small business lenders, as well as simplifying tax dispute resolution with the ATO.

Australian Invoice Finance welcomes these changes but understands that they will take time to be introduced to Parliament, if in fact the Liberal Coalition is able to remain in power.

In the meantime, small businesses have other non-bank options to explore and, through their brokers, should be guided on how to tap these.

Greg Charlwood

MD of Australian

Invoice Finance