A graphical summary of three key Fintech verticals – Lending & Credit, Payments and Wealth Management. Useful?
The original article was published by Entrepreneur Country on 01/11/2013.
Cash flow problems account for a huge percentage of corporate bankruptcies and are a major cause of financial distress to UK businesses. £36 billion was owed to UK SMBs (small and medium sized businesses) at the end of 2012 due to unpaid and overdue invoices. More than 124,000 businesses said they have come close to shutting their doors permanently as a result of cashflow problems resulting from extended invoicing terms and late payments from their buyers.
Cash flow worries have led to a surge in adoption of alternative financing services. Crowd funding, invoice financing, angel investors and even government grants have emerged as options for businesses struggling with cash flow concerns. However, though easier to access than traditional finance such as bank overdrafts and loans, these forms of credit are more often than not relatively more expensive for SMBs than for their larger customers.
Championed by the UK government, Supply Chain Financing (SCF) is quickly emerging as the best alternative solution for low cost working capital finance for businesses.
In many ways SCF is the same as Invoice Financing/Factoring – the practice of receiving short-term credit against the security of an invoice as yet unpaid.
The critical difference between SCF and Invoice Finance (IF) is that it is the customer not the supplier that works with the lender, historically a bank, to enable seamless early payment of the invoices to its suppliers. Suppliers are offered the opportunity to receive early payment and can choose to opt in to the scheme or not. The “credit” comes in the form of a discount on the value of the invoice. For example, if a customer typically pays on 60-day terms, a supplier could receive immediate/early payment if they accept a small discount on the face value of the invoice.
The benefits of SCF to both the customer and supplier far outweigh those of other working capital solutions.
Firstly, the credit risk and thus the cost of the financing are related to the customer, not the supplier. Due to the direct relationship with the customer, the lender’s fraud risk is also reduced – there are no “ghost invoices” to worry about, no worry around disputes over payment or returned goods. These factors help make SCF the lowest cost option for working capital finance for a supplier. Suppliers can receive early payment on close to 100% of their invoice value. With IF, early payment is generally around 60%-80% of the invoice value.
Furthermore, SCF provides for total transparency in the use of the credit facility; the relationship between supplier and customer often becomes strained when a lender is chasing the customer for unpaid invoices in an IF solution. Invoices are pre-approved for financing as opposed to a supplier struggling to obtain the evidence they need for IF.
For the customer, SCF helps cement a robust supply chain and can actually make their cash work harder, enhancing their own working capital, and can potentially help generate a new and small income stream.
Win-Win for all involved.
SCF has traditionally been targeted at large corporates with a large supplier base. This is changing as technology and processes to assess risk are improving. New services, such Tradebridge, aim to facilitate SCF for medium sized businesses, helping them, and their suppliers, to access the benefits of SCF.
Mark Coxhead, Managing Director of an innovative new SCF business called Tradebridge said to me, “We utilise proven technology to help us deliver a simple, easy to use solution designed for medium sized businesses, typically with between £20million and £100million in revenues.
Our goals are to allow these businesses to realise the benefits of SCF without adding any friction or cost to their existing processes and to help their suppliers overcome cash flow worries. Our service also gives more control to the supplier, allowing them to get cash early for their invoices when and as they need.
Our technology enables us to cut out a lot of the overhead that larger lenders/banks have to cover in their lending rates. As such, we are able to offer market leading finance that is lower cost than that of other providers.”
Automation around invoicing is core to optimising the SCF process, and to invoicing in general. E-invoicing should, particularly in this age of technology, be the defacto method of billing between the supplier and customer; many solutions, such as Invoiceable, are free, others are in-built to common accounting packages.
Paper invoicing is the source of a great amount of confusion on invoice status. Paper invoices are difficult to track and thus create inefficiencies in the invoice approval process. PDF attachments to emails are not much better; they are invariably at risk of being ignored.
A clear, robust and automated process around invoice handling can even free up previously hidden cash within an organisation. For customers, greater clarity about what has been spent, what’s outstanding and invoice status can lead to more rapid processing, helping them to avoid late payment. A transparent system also fosters greater collaboration between suppliers and customers, leading to new opportunities.
Invoicing terms are the main driver of cashflow issues facing SMBs in the UK today. The lack of cheap and accessible credit further exacerbates the issues SMBs face. Managing finances does not need to be so difficult; Supply Chain Finance offers a myriad of benefits to both suppliers and their buyers and is now accessible to a wider community of businesses. Technology has made SCF relatively pain free to implement and use and has helped to lower the financing costs. Implementing SCF should be a top priority for any Financial Director.
Orignally published in Entrepreneur Country, 19 June 2012.
Here we go again – bailing out the bankers under a veil of helping out small business.
I read the following article, published in the Wall Street Journal (and I am sure elsewhere) with a knowing smile on my face.
Lets leave aside the irony of a bunch of wealthy politicians preaching to a bunch of wealthy bankers at an expensive and exclusive black tie event about how they are going to help “the little people” (I love the pic!), and focus on the proposal.
“Mervyn King announced plans to flood banks with cheap funds in an attempt to jump-start lending to British households and businesses….”.
Let me tell you a little about how banks work. They are privately held entities. Like other firms listed on the stock market, they do what is best to maximize return for their shareholders. If they have 100 units of capital, they, like any other private firm, will look to allocate the 100 in the most effective way to generate the maximum level of return on that capital.
Banks are not responsible for saving the economy, that is the job of the government through public policy and expenditure and by delivering the right incentives to the private sector to do what is best for the whole while also helping themselves.
So, by providing cheaper loans to banks is the government providing the right incentives to the banks to open up lending to SMEs and households? No – and they know it.
All the government is doing is helping the banks more easily raise capital. How they use that capital is not, and will not, be dictated. Yes, some of it will find its way to you, I and our businesses. However the vast majority will go towards the capital markets functions of the banks and in lending to large corporates. The reason is quite simple; lending to SMEs and households is the most expensive activity for a bank to conduct in terms of capital utilised.
A loan portfolio consisting of SME loans is considerably more expensive to hold then a loan portfolio of large corporate loans. Obviously the revenue the banks earn also defines the return on capital. Let’s say, on average, a bank earns 8% on SME loans and 5% on large corporate loans. This 3 percent difference in no way compensates the difference in the capital requirement between SME and Large corporate loan portfolios, which can be as large as 20%. Now also factor in the off balance sheet activities of banks – the complex derivatives they trade in the capital markets division that can reap them considerable revenues but cost the bank nothing in terms of regulatory capital.
So, if a bank has 100 units of capital available, what would it do it with it? Well given the incentive structure, in this case, the capital requirements dictated by regulatory bodies such as the FSA, Bank of England, the EC and the Basel Capital Accord, they would allocate zero of that capital to lending to SMEs in order to maximize their shareholder’s return. This is why Project Merlin, the effort by the Government to tie banks to lending targets, failed – though a token effort was made due to brand necessity, the proportion of loans made to SMEs relative to large corporates fell considerably and continues to fall. This is also why the stimulus package announced at the event covered by the Wall Street Journal will also fail – the incentives are simply not there for banks to lend to SMEs. Given the current trajectory of regulation, I would even stick my neck out and state that banks will exit the business of lending and generally providing SME services within the next 10-15 years. SMEs should be looking at the new finance/Fin-tech sector for support as it is fundamentally the future for SME finance and banking services.
As a spin on the Government proposal and the general conditions for banking at the moment, why don’t you help me take advantage of the situation? I promise at least 20% Return on Equity for any investor who will help me set up a bank. Here is my high level business plan – any takers? 😉
- I employ some currently unemployed bankers (adding value to the economy)
- We raise £1 billion of equity
- We use the £1 billion to buy as much high-grade securities as we can (minus set up costs), paying maybe 4-5% coupon
- We use the securities as collateral to borrow £9 billion from the BofE at overnight rate of 0.5%
- We buy another £9 billion of securities at similar rates as the first batch. At this rate, we are earning at least £400 million per annum
- We continuously roll the overnight position with the BofE, pledging more of the security pool in collateral if required on margin calls
- We go public. After costs, the bank is earning at least £200 million a year with a high capital ratio (10% equity-to-debt), and the balance sheet will be clean (all low risk securities). Potential valuation of 20-times earnings: £4 billion. We sell 25% of the company for £1 billion
- Put the £1 billion raised to good use – go back to Step 3
- When market cap hits £10 billion, sell another 10% of the company for £1 billion. Go back to Step 3 again
- Expand to US. Fed is lending at 0.25%. Repeat formula. Start focusing on PR and social issues, buy branch networks from defunct banks and start making actual loans to retail and corporate consumers
- Exit for a ridiculous valuation. We all win!