How to manage extended credit terms?

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In recent years, the extension of MNC credit terms has become business as usual across the globe. But for SME’s it’s anything but business as usual. Consider, “How would an extension of credit terms impact on your clients’ cash flow and projections this year?” and “What are the implications for their growth strategy in 2020 and beyond?”.

Winning a contract with a large MNC is a measure of success for established SME’s however, an extension of credit terms can feel like a double-edged sword as it puts excessive strain on cash flow.

Why does it matter?

A strain on cash flow can have many implications, all of them negative.

The first impact is on Suppliers. They expect payment in 30 days. Immediately, there’s a gap in cash flow and your client is unlikely to have sufficient sway with their suppliers to realign. This could mean:

  • The SME is not in a position to fund the initial costs of fulfilling contracts
  • Puts pressure on existing supplier relationships – increased risk around quality, timely delivery and higher prices
  • Dilutes the SME’s capacity to deliver on-time to their customers
  • Slows down the SME’s ability to grow their business at pace

The Lost Opportunity

It may seem obvious but having cash tied up in Debtors with long credit terms is a fundamental challenge for most SME’s. If SME’s could access this cash early, it would give a distinct competitive advantage when negotiating terms with key Suppliers.

Consider what the SME could do if their invoices were paid on Day 1, not Day 90. Firstly, the SME could pay their suppliers early, enhance the relationship and ultimately secure better terms. Secondly, they could deploy funds into driving new customer acquisition and fund New Business Tenders with the comfort of cash flow certainty.

So, what does your client do?

They have two options:

1          They could try to negotiate

Know where they stand in their customer’s eyes. Is their product or service critical to product or service delivery? Even so, unless your client is the sole producer of a key strategic element, there’s another company out there to potentially replace them. Alternatively, the SME’s customer might offer softer credit terms in exchange for a pricing discount. But, cutting margins is an extremely expensive source of finance and unlikely to be recovered. This course of action doesn’t make good business sense. It’s a race to the bottom.

2          Introduce working capital funding options to bridge the gap

The financial market is developing all the time to reflect the needs of business. For decades, when Ireland’s SME’s needed to fill the cash flow gap left by extended credit terms, they had limited choices – commercial overdrafts, short-term lending or an Invoice Discounting Facility.

That may have been adequate in the past but such is the success, ambition and global reach of Irish SME’s across all sectors today that this range of funding options falls short of their requirements.

Commercial overdrafts are harder to secure and are generally seen as an unreliable method of funding not directly aligned to the changing requirements of a business. Similarly, short-term lending is onerous to put in place and comes with significant levels of conditionality. An Invoice Discounting (ID) Facility continues to plug the cash flow gap for many SME’s in Ireland however ID Facilities are operationally clunky and carry significant fixed and hidden costs and limitations – not really fit for purpose for today’s SME’s.

Many SME’s often have a small number of key strategic customers in their sales mix. Supported by Government bodies such as Enterprise Ireland, Ireland’s SME’s have a global footprint. Exporting is crucial to scalable business success. And not just Western Europe, SME’s are securing contracts across the globe – US, Canada, EMEA, Middle East and Asia.

Invoice Discounting (ID) Facility

For years the ID Facility has serviced working capital funding requirements. However, the facility comes with 3 major limitations:

  • The Facility Limit
  • Geographical Restrictions
  • Debtor Concentration Risk Limits

1 The Facility Limit
At the outset, the SME is subjected to a long and onerous process to get approval for the ID Facility. Fair enough you may say as this is effectively a loan and it follows that the Bank providing it decides how much the Facility is for. The SME must enter into a long-term commitment, often saddled with ‘non-usage charges’ or ‘exit fees’. The SME must also pay credit insurance and sign a personal guarantee – something entrepreneurs have grown to fear.

2 Geographical Restrictions
Exporting to the UK, great. Exporting to United States (US), not so great. Country risk and the law of the land plays a major role in how traditional lenders assess the risk and granting of facility limits. If the country in which their customer is located is outside of what is considered in banking terms to be palatable, funding limits and exclusions will apply.

3 Debtor Concentration Risk Limits
The most common reason for restricting funding under an ID Facility remains Debtor Concentration. It applies when an SME becomes ‘over-exposed’ to a single debtor. The Debtor could be a large household brand name but traditional lenders must impose facility limit restrictions. For the SME, it is somewhat ironic that the more business they do with a key customer, the more their funding is limited.

So, back to their US MNC extending credit terms.

Your client has worked tirelessly to win this business but they cannot sustain 90 days credit, and this customer accounts for over 60% of their debtor book.

The business needs:

  • Consistent certainty of funding, without any limit relating to Geography or Debtors
  • Funders who recognize the strength of their business model and the substance of the underlying transactions
  • Access to working capital to scale their business globally

Market and Product Innovation

Invoice, Purchase Order and Recurring Revenue Trading, collectively known as “Receivables Trading”.

Receivables Trading ticks all the boxes. It enables SME’s to leverage on their customer relationships. By selling invoices and future invoices (Purchase Orders) to a pool of Capital Market Funders SME’s can access finance immediately when they need it.

What difference does Capital Markets Funders make?

The funders are Capital Market institutional funders, Pension Funds, Corporates and ssophisticated Investors. There is a large pool of these funders. The fact that there is not just one entity but a pool of funders purchasing the Receivables (Invoices or Purchase Orders) eliminates the requirement for imposing concentration or geographic limits on the SME. It extinguishes the needs for any commitment, lock-ins or fixed costs. At no stage is there an ask for a Personal Guarantee. This funding solution puts control back into the hands of the SME and allows them to decide when they need to access funding on their terms – a liberating benefit.

How does it work?

Receivables Trading is available via an online platform. A Pool of Institutional Funders (the Buyers) are Members of the platform. The SME (the Seller) uploads their Invoice or Purchase Order and the Buyers buy them. The model is ideally suited to established SME’s with Multinational Company (MNC) or Sovereign Debtor(s). The SME can use the online platform in conjunction with their existing facility by carving out specific Debtors from the ID Facility.

In Conclusion

Business is constantly changing and Working Capital Funding has caught up. Alternative funding where Sellers and Buyers connect directly via an online platform is fast becoming the norm. With this funding solution, SME’s can tender for business of any scale globally – confident that they can fund the upfront costs. It’s a game changer for most.

According to the Central Bank Survey of SME’s Jan 2019, the top 2 reasons for credit applications were: 1 Working Capital and 2 Growth and Development. ISME’s quarterly business survey, reveals that 70% of Ireland’s SME’s still rely solely on traditional Bank funding. In Europe, it’s only 30%.

Alternative funding is the future of funding.



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