/ 24 July 2008

Invoice financing to raise capital

Raising working capital is seen as the ultimate challenge for most small and medium business enterprises particularly in their early development.

Raising working capital is seen as the ultimate challenge for most small and medium business enterprises (SMEs), particularly in the early stages of their development.

Unlike listed public companies, they do not have the facilities of a shareholder base or corporate backing, to raise capital through share schemes and other financial mechanisms. For SMEs “cash-flow is king”. This money is critical for the day-to-day running of a business.

Roger Herbert, executive secretary of the Banking Association’s debtor financing committee, maintains that small businesses should use invoice financing to help raise working capital. The Banking Association of South Africa is an industry body representing all registered banks in the country. The debtor financing committee represents the specialist divisions of commercial banks and other financiers that finance debtor invoices.

Herbert points out that small business enterprises are a key driver in stimulating economic growth. For them to succeed it is critical that they are able to direct a consistent flow of working capital to their businesses. Debtor or invoice financing facilitates this, he argues, by creating an unlimited model for future growth. Yet fewer than 2 000 companies in the country make use of invoice financing.

But this is changing. Herbert says that as misperceptions about debtor financing are challenged by the industry and as finance houses and banks become more aggressive in their promotion of products, more companies ­- among them SMEs — are starting to appreciate the benefits of debtor financing. “Debtor financing offers companies with creditworthy debtors a viable means of accessing cash, no matter if they have a less than desirable balance sheet.”

A “less than desirable” balance sheet with insufficient gearing and a poor liquidity ratio is a common obstacle for many entrepreneurs looking to secure bank loans or overdrafts. Herbert says that in this type of situation a good debtor’s book could well be the answer to facilitating working capital. “Creditworthy debtors are business assets which can be leveraged. Invoice financing essentially involves a bank or finance house ‘buying’ or ‘lending’ against debtors’ invoices. One is therefore advanced funds against one’s invoices.”

This makes debtor financing the ideal “remedy” for lengthy payment processes of many reputable debtors. “Despite Thabo Mbeki’s undertaking to pay smaller suppliers within 30 days, we’re still seeing bureaucracy and lengthy internal processes within government and large corporates stymie the growth of many start-up enterprises. Failure to pay according to the agreed terms of the usual 30 days has an extremely negative impact on a SME. Most do not have access to working capital to ‘tide themselves over’ during this time. Wages and suppliers very often cannot be paid as a result.”

In a recent initiative to generate economic growth and to help drive sustainable enterprise development, professional services firm KPMG teamed up with Absa Corporate and Business Bank in the launch of the KPMG Enterprise Development Initiative, centred on skills and knowledge transfer within the black-owned medium business sector. It targets enterprises that are more than 50% black-owned with a turnover of up to R35-million a year.

South Africa has a low rate of entrepreneurial activity compared with other developing countries, with entrepreneurs contributing only 35% of GDP, compared with 60% in countries like India and Brazil, according to research estimates.

Says Moses Kgosana, chief executive at KPMG: “If we consider that more than 95% of South African businesses are SMEs, then large organisations need to find proactive ways in which to support the viability and sustainability of this growing sector.”