DP Information Group had recently conducted a credit survey on Small and Medium Enterprises (SMEs) in Singapore and found that SMEs are tightening their credit terms. Their most eye-catching result was captured in the chart below which shows that SMEs are getting paid a full 19 days to cash (DTC) earlier than just two years ago.
Source: DP Information Group
Given that SMEs form 99% of business enterprises in Singapore and contribute 50% of GDP, this is a significant development. This places an effective constraint on the credit terms that any business can get from their suppliers.
The most common credit terms would be 30 days after receipt of the invoice, and SMEs are effective at enforcing these terms. SMEs are also conducting rigorous credit background checks on their clients to reduce the risk of being straddled with bad debts.
Strategies for the new normal
Suppliers are not willing to extend generous credit terms to get the business. This is because they will have to get SME loans and the financing charges will compress their profit margins. The new normal of tighter credit terms would be good for the overall financial health of SMEs, but this will force businesses to rethink their financing strategy.
Instead of wasting effort to look for suppliers that would allow you to lean on their credit terms, here are three new strategies for businesses to adapt to the new normal.
1. Tighten credit terms with debtors
When your suppliers tighten their credit terms, you must also tighten your credit terms with your clients. If not, you will be faced with a lower cash flow and you might also be forced to get additional loans, and the financing cost will eat into your profit margins.
2. Invoice financing
If you are an SME dealing with large corporations, you might have to offer better credit terms to secure the business. In that scenario, you might want to turn to invoice financing to deal with the delayed payment of 30 to 90 days. Invoice financing is the sales of your invoice as an asset to a third party for immediate cash at a discount.
The discount would be the cost of financing. It should be highlighted that invoice financing is not a loan and this would not cause your company to breach its loan covenants with your existing bank. There are basically two types of invoice financing: notified and non-notified.
2a. Non-notified invoice financing
The more common method would be the non-notified invoice financing method where the client is not told that their invoice had been sold.
The invoice discounting company will have assessed the credit risk of your company and your client and incorporate their fees into their charges. Once you present the invoice to them, they will pay you 80% upfront.
The first new debtor for non-notified invoice financing would normally take a longer period than the notified invoice because of the need to create a special account where the discounting company is the signatory but the name of the account is your company.
As far as your client is concerned, they are paying you but once their payment is made, the discounting company will withdraw their principal advanced amount and fees.
2b. Notified invoice financing
In the notified invoice financing scheme, your client will know that their invoice had been sold to a third party. This will make some clients uneasy as they will have to deal with the invoice discounting company if they are late on their payments. This can be overcome with good written and verbal communication with your client. In any case, you will have 80% of your invoiced funds upfront and the rest later.
For each new debtor, there will be a credit check but the overall process should be faster as there is no need to open a new account to accept the payments. The debtor will pay the invoice discounting company directly.
One category of business that would require regular invoice financing would be labour-intensive industries. They are obliged to pay their employees promptly under the labour law or their directors would face regulatory penalties. This applies even if their clients are late in their payment. Invoice financing allows them to get around this problem.
3. Increase financing facilities early
The last method would be to increase the cash on hand to deal with tighter credit conditions. The only way to do this besides an equity injection would be to increase your debt. For businesses, they should ask for a loan early before they are forced to do so.
Ironically, this will reduce their chances of getting their loans approved. The main drawback of this method is that banks can take one to three months to approve the loan. So if the funds are needed urgently, this is not a useful avenue for most businesses. This is the case regardless if you are a small events company or a major retailer.
The best strategy
Among all these three strategies, the best for SMEs would be invoice financing. Invoice financing addresses the issue of tighter credit conditions directly. Businesses don’t have to risk alienating their clients by insisting on tight credit terms and they can avoid getting term loans. They need to partner with an invoice financing company with a robust system to enable a fast turnaround time.
Term loans usually last for one year or more, which is longer than the trade credit terms that most businesses extend to their clients. Besides the dollar and cents of the financing charges, the most important aspect of invoice financing is that it allows businesses to chase after the good opportunities as their capital is not tied up.
For instance, if a company comes across a rare business opportunity that will allow them to earn 100% returns in one year but they must act by placing a deposit by the end of the month, if their funds are tied up by their clients, the only way that they can act upon the opportunity is through invoice financing.
Singapore is a global financial hub and there are several players in the market that could extend invoice financing. For businesses, before they choose their invoice financing partner, it is imperative that they choose an independent advisor to help them navigate the terrain.
Some of the important questions would include those about their fees, terms, track record, and if the company has the necessary funds to grow with you.
Business environment changes over time and the nimble-footed business would thrive in this new normal.
The views expressed in this column are the author's own and do not necessarily reflect this publication's view, and this article is not edited by Singapore Business Review. The author was not remunerated for this article.
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Ong Kai Kiat is the founder of TextInAsia, a Singapore-based independent source of insights in the fields of finance and technology. He had years of experience in contributing articles to various reputable websites. TipRanks had ranked him internationally as a four-star blogger for his work in finance.