Funding - the lending dilemma

ECONOMISTS CONTINUE to portray a mixed view of the economy, leaving businesses uncertain whether to be optimistic about the recovery or cautious about what tomorrow’s headlines may bring.

Recent uplifting reports include corporate insolvencies decreasing for the sixth consecutive quarter, and Markit’s purchasing managers index showing consistent growth in the services sector – making up nearly half the UK economy – in Q3 2010.

Yet this is offset by a 0.5% decline in the UK economy last quarter and the OECD’s predictions of another UK downturn, resulting from major fiscal tightening and persistently tight credit conditions. House prices are also still falling and the latest figures from the British Retail Consortium show paltry sales growth. This uncertainty about the overall economic outlook is having a detrimental impact on the ability of UK businesses to grow.

The long tail of recession
The truth is we are still operating in confusing times. Most importantly, cash availability still has not returned to pre-recession levels, with R3 (The Association of Business Recovery Professionals) warning that more business insolvencies are still to come.

Our annual Credit Check survey of UK accountants echoed these concerns. One third of accountants questioned rated UK business strength as ‘weak’ or ‘very weak’, while one in four of their clients were exceeding working capital.

With SMEs accounting for 99.9% of all businesses in the UK, according to BIS, this unstable scene is likely to worry those responsible for supporting economic recovery.

Working capital?
Our research highlighted three key areas where SMEs need help; not in the shape of handouts, but ‘help to help themselves’, to increase their capacity for new business and set them on the road to recovery. It is essential for lenders and accountants to understand these barriers, so they can adapt and advise accordingly.

The first major issue is a lack of working capital. The survey indicated increasing cautiousness amongst SMEs, with over half (53%) of accountants noticing their clients becoming more inclined to check the creditworthiness of their new customers.

Similarly, almost half (44%) of accountants have seen their clients increase demands for upfront payment from their customers; a direct reaction to an increase in debtor days, which 78% of accountants have seen increase by 14 days or more in the last six months. This additional prudence is welcome, but will restrict cashflow and make it harder for SMEs to open up new business opportunities.

Accountants can help to alleviate this difficulty, principally by encouraging clients to tighten up their invoicing and debt collection or putting in place arrangements to ensure payments are brought in on time. On the other side of the equation, clients should be encouraged to become better debtors too, aiding the overall flow of capital amongst SMEs.

Access all areas
The Credit Check also uncovered strong evidence that SMEs are still lacking access to finance. Nearly two thirds (60%) of accountants believe finance is barely available to the UK’s SMEs, and consequently 80% have seen clients lose faith in traditional finance.

The effects of this are significant, especially as many businesses lack understanding of the ‘menu’ of financing options that are available to support growth today. Reflecting this difficulty, over half of accountants (54%) believe SMEs are currently using the wrong finance for sustainable growth.

The lending community has begun to address this knowledge gap with some success, but there is still work to be done. By exploring the broader range of options available, accountants can advise effectively in the current financial environment. For example, unsecured finance is still not widely accessible for many, whilst equity finance, business angels and invoice asset based lending are becoming increasingly available according to our study.

Viability for funding
SMEs are also struggling to demonstrate viability to lenders, as recession-battered balance sheets paint a distorted picture of their potential profitability. This suggests that a more forward-looking and innovative approach to establishing new finance relationships is necessary to aid SME growth and broader economic recovery.

This change comes partly from lenders, but accountants are also valuable partners in this respect. They are in an ideal position to help clients tighten up their finances, and can help businesses give a clear picture of potential future numbers to prospective lenders and other financiers.

Redefining relationships
Of course, businesses have very specific needs depending on their current financial situation and growth plans. Going back to the idea of helping SMEs to help themselves, and offering finance that works, accountants and financiers need to work ever more closely together to adopt a more common-sense approach to lending.

It almost goes without saying, but lending needs to be based on a trusting financial relationship. This means accountants need to gain a deeper understanding of clients’ businesses and partner with lending organisations that share this principle. This will deliver a sustainable funding solution for the client now and in the future, adapting to changing needs and making it easier to support growth and new opportunities.

A business’s relationship with their financier should be based on the same guiding principles that govern their everyday working relationships with their accountants. Fundamentally, this means looking at long-term goals and benefits, openness and honesty, and encouraging an ongoing two-way dialogue. Building and maintaining this kind of relationship is mutually beneficial and will be infinitely more constructive in today’s business environment. In fact this was the overriding solution to come out of our recent think-tank event where our panelists met to discuss the way forward in financing Britain’s growth.

The panel also agreed that the current tentative mood amongst SMEs has been created largely through uncertainty. The key worry businesses face is whether funding streams there today, will still be there tomorrow. Almost a third (31%) of accountants’ clients had traditional funding withdrawn or conditions changed during the recession. Now almost two thirds (62%) believe reliability is more important than cost alone when considering business finance. SMEs need to know they will have the finance they need in order to plan, strategise and make those vital moves towards growth.

While accountants cannot directly affect this process, it is part of the broader education that needs to take place. The possibility of changes to finance relationships is always there, so businesses need to be aware of this. But SMEs must also be given the information that will allow them to explore and understand the wider funding opportunities to build a stable foundation for growth.

Clearly there is a long way to go in getting the SME ‘engine’ back to full working order. On one side the onus is on lenders to concede some ground and rethink some of the established principles that may no longer hold true. But businesses themselves will also need to ‘get clever’ – the laissez-faire credit days of traditional finance are over and a greater rigour and knowledge of financing options is going to be necessary for success. The accountant’s role in this process is paramount in bridging the gap in SMEs’ understanding of what’s changed and how they can take the first decisive steps towards recovery.

Peter Ewen is managing director of Venture Finance